Ausnet Transmission Group Pty Ltd v The Commissioner of Taxation of the Commonwealth of Australia [2015] HCATrans 76 (9 April 2015)

Last Updated: 9 April 2015

[2015] HCATrans 076

IN THE HIGH COURT OF AUSTRALIA

Office of the Registry
Melbourne No M139 of 2014

B e t w e e n -

AUSNET TRANSMISSION GROUP PTY LTD (ACN 079 798 173)

Appellant

and

THE COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA

Respondent

FRENCH CJ
KIEFEL J
BELL J
GAGELER J
NETTLE J

TRANSCRIPT OF PROCEEDINGS

AT CANBERRA ON THURSDAY, 9 APRIL 2015, AT 10.14 AM

Copyright in the High Court of Australia

MR S.H. STEWARD, QC: If the Court pleases, I appear with my learned friends, MS L.A. HESPE and MS K.J. DEARDS, for the appellant. (instructed by Deloitte Lawyers Pty Ltd)

MS H.M. SYMON, QC: If the Court pleases, I appear with my learned junior, MR E.F. WHEELAHAN, for the respondent. (instructed by Australian Government Solicitor)

FRENCH CJ: Yes, Mr Steward.

MR STEWARD: As the Court will have seen from our written outline, we propose to address the matter by dealing with the negative limb first, the question of whether the payment was on capital account, and then we will address the positive limb after that, which is the point raised by the notice of contention.

Let me address the negative limb first. There is an anterior issue which does need to be decided before we get to determine the character of the imposts in question. The anterior question arises because, perhaps surprisingly, the parties do not agree about what is the source of the liability. My learned friends say the source of the liability is a promise to pay the imposts contained in a contract called the asset sale agreement. We do not agree. Our primary position is that there was no promise to pay the impost, but rather the source of the liability arises from the Order in Council which was authorised by section 163AA of the Electricity Industry Act. We simply paid a tax which was part of the regulatory regime.

FRENCH CJ: Did that liability crystallise upon transfer?

MR STEWARD: It crystallised upon us being the holder of the licence at the specified dates in 1998, 1999, and 2000. The reason why we need to decide that issue first is because deciding that issue correctly will then tell you what was the advantage, if any, obtained. This is a bit like the South Australian Battery Makers Case where, in the judgment of Justice Gibbs, as his Honour then was, his Honour said that the first issue to decide is what was the advantage obtained and in order to decide that we need to ask the anterior question, why did we pay it? Why are we being made to pay this impost?

The first issue is confessedly largely one that turns upon the factual material before the Court. The second issue, which is this - if we are wrong, if we are wrong that the source of the liability is the order, and if my learned friends are right that there was a promise given in the asset sale agreement then we, in our submission, still win and we do so for the reasons largely given when we sought special leave, namely asking the question what was the price for the transmission business is not the correct question to ask. Rather, one must ask from the perspective of the taxpayer, what advantage was secured by paying these imposts?

It will be our submission that there was, on the one hand, a purchase price that was paid – some $2.5 billion – called the total purchase price in the agreement. The imposts were a separate matter altogether. The dictum of Justice Fullagar from the Colonial Case that was applied against my client below really needs to be read in context as merely a description of the usual outcome and not a discrete test. The correct test for the negative limb was what is the character of the advantage sought? What was it calculated to effect? Now, could I turn to that anterior question? We should commence with the section in play, section 163AA, which is attached to the submissions.

FRENCH CJ: Incidentally, what reprint of the Electricity Industry Act should we refer to? There is Reprint 30, I think, and Reprint 40.

MR STEWARD: Your Honour, I think we are agreed between us that it is the one dated 27 November 1997. The section has not materially changed before its repeal. In our written submissions, we made two observations about the language of this section which we respectfully submit are important. The first proposition was that by its terms this provision creates a power to impose charges but only on a certain type of exigible entity. The type of exigible entity is the holder of a licence, relevantly, here, a transmission licence. There is no more general power to impose charges on anybody else.

Secondly, we submitted that the manner of imposition is rendered expressly clear – liability will arise – and the words are “as an impost”, not as a contractual promise but as an impost, that is, with respect, as a special tax imposed by the State on a very narrow class of exigible entity and as one might expect with a tax, it is paid in to the consolidated fund.

Could we make three further observations about this provision? The power is broadly linked to Victoria’s privatisation program. We do not deny for a moment that the imposts are connected to and are bound up with the privatisation of the transmission business. There is no attempt to deny that. We can see how it is bound up with the privatisation program in subsection (3). Subsection (3) by its terms turns off the power to make the order if the relevant transmission company has already been privatised.

So you can only make the order before privatisation which is why, as we shall see, the order was made some six or seven days before completion of the contract and transfer of the transmission licence. But secondly, other than that connection, the provision by its terms and on its face gives a power to impose charges without regard to the sale of any electricity business. It does not turn upon sale as the font of the power to impose the charge.

GAGELER J: But could it only apply to place the impost where a sale has occurred?

MR STEWARD: I think, your Honour, that is the expectation, yes, that it will only take place before privatisation and subsection (3)(1) infers - was, if you like, a statement by the State that it would not impose any more charges once you privatised.

GAGELER J: So it could only apply in respect of the transmission assets to be sold - - -

MR STEWARD: I think, your Honour, we would submit it can only apply to what is called a public transmission company.

GAGELER J: Yes.

MR STEWARD: That term is not defined, but one imagines it is intended to refer to a transmission company which has not been sold. The third - - -

NETTLE J: I am sorry, Mr Steward - - -

MR STEWARD: Yes, your Honour.

NETTLE J: It would have been open to impose the charge on PNV even if the company’s assets had not been sold.

MR STEWARD: Yes.

NETTLE J: Even though it is unlikely any such charge would have been imposed.

MR STEWARD: Correct, precisely.

NETTLE J: It was open to do so.

MR STEWARD: Yes, it was. At that time, your Honour, I think it is common ground PNV would have paid notional tax to the State Government in any event, so it would have perhaps made no sense to do so, but it was open, yes. The third observation I wanted to make clear about section 163AA is that there is a separate charge which the holder of the transmission licence must nonetheless pay annually, and that is derived not from section 163AA but from a clause in the transmission licence itself, clause 16. I do not need to take the Court to it.

Could I then invite the Court to go to the Order in Council which appears at appeal book 3. It may be attached to submissions. In any event, before I take you to the language of the Order in Council I wanted to make five broad propositions, which I do not believe are in dispute. I make these five broad propositions to provide context to why the Order in Council was made.

The first proposition is that in order to undertake a transmission business in Victoria you needed to have a licence – section 159 of the Electricity Industry Act. Secondly, as a licence holder, the revenue one could charge at that time was regulated. It was regulated by a tariff, and the tariff imposed what is known as the maximum allowable revenue, known below as the MAR. So there was a cap on the revenue you could earn.

Thirdly – and this is not in dispute – the State made a mistake in determining the MAR. In a review that took place prior to privatisation, it realised that the MAR was too high, and had to address that problem. Theoretically – and this is an important point for us – that discovery could have taken place after sale. The review that took place did take place before sale, but theoretically they may have discovered that the MAR was too high post-sale.

Fourthly, the imposts in question here exist as the solution to the problem. What they do and what they are intended to do is to remove the excess of MAR in the period before they were free to correct the MAR. They were not free to correct the MAR until the distributor companies, who also had a retail business, until the tariff regulation for the retail business was removed in 2000.

FRENCH CJ: There was some variable called X, I think.

MR STEWARD: The X factor, your Honour.

FRENCH CJ: Yes.

MR STEWARD: I have hesitated to refer to it in that way. I make it clear it does not refer to the quality of our arguments. It is a mysterious factor designed to enable the MAR to be adjusted annually – CPI times X.

FRENCH CJ: Yes.

NETTLE J: The X factor could have been amended by legislation to do what was done with these additional charges, could it not have?

MR STEWARD: It could have, and another option that was open to the government that was not taken was when they came to adjust the X factor in 2000, they could have adjusted it in such a way as to recoup the excessive MAR from the previous years. That is important because what this is telling you is that the purpose of the imposts is nothing to do with the sale of the transmission business as such. It is about the income earned after it, and about making sure that the entity only earned the correct amount and not an excessive amount.

GAGELER J: If the MAR had been reduced before the sale, the expected income stream from the asset sold would have been reduced - - -

MR STEWARD: Yes.

GAGELER J: - - - and the sale price would have been, presumably, reduced.

MR STEWARD: Absolutely correct. There is no question about that because, of course, your Honour, the calculation of sale price takes place by reference to future cash flows discounted. There is no doubt about that. But all outgoings have to be taken into account in deciding that. Cash flow – that includes salary and wages, operating expenditure, all of those things will affect the sale price but it does not tell you whether those outlays when incurred are on revenue or on capital account.

But the point your Honour made is an important one because if, of course, the government had had the capacity to reduce the MAR we would not be here because economically what my learned friends are seeking to tax here is MAR that we have to give back. It is MAR that we do not enjoy economically because we give it back by paying the impost.

That is an important point to understand here when looking at this from – as we are urged to do so – a practical and business point of view. What my learned friends are really, really trying to do is tax income that economically we have to give back, that we do not economically enjoy. I will return to that later on, if I may.

FRENCH CJ: But your characterisation argument really focuses upon the character of the liability which you say derives from the statute read with the order?

MR STEWARD: Yes, that is our primary case that really what happened here is we paid a tax which secured for us no advantage but reduced our income. That is our primary case.

KIEFEL J: It was a tax on gross profits?

MR STEWARD: A tax on gross revenue, as we shall see, not profits – gross revenue. The final proposition which I have not yet made here by way of background is that having removed the excess MAR over 1998, 1999, 2000, the impost ceased to apply. So the timing of the impost – why are they made in those years and why do they stop – is bound up with the ability in 2000 to correct the MAR in a way they could not have done before sale in the way that your Honour just mentioned.

The Order in Council, if I could take you to it now, is at appeal book 2, page 742. I am not going to read it out. I just want to make the following observations – short observations, if I may. First, we again see the same language as that invoked in section 163AA, namely, the reference to it being an impost and an impost imposed upon a particular type of entity, the holder of the transmission licence.

Secondly, each of the charges is tied to particular years in which the holder of the licence earns income from the exploitation of the rights conferred by it. The required nexus for each year is conveyed by those very favourite words in statutes, the words “in respect of”.

Thirdly, and, with respect, contrary to the contentions of our learned friends, this order did not create in 1997 a present liability to be discharged in future years. The key word, with respect, is the word “payable” and its conjunction with particular dates in future years. The liability is not payable in 1997 only to be paid out in future years. Rather, liabilities become payable on particular future dates. As best as I can see, there are 12 instalments that are required, or 12 payments, beginning on 31 March 1998 and finishing on 31 December 2000.

What is significant, of course, is not only is it payable on future dates, but it identifies the person who will pay it then as being the person who holds the licence. The final words of the order make it clear that the draftsperson expressly contemplated – indeed, had to contemplate – that the person who would bear the liability in the future years would not necessarily be the first person identified as holding the transmission licence, namely the vendor, PNV. This order applies to any person to whom the transmission licence is transferred. In our respectful submission, in 1997, what was created by the Order in Council was a future liability and a contingent liability, the contingency being that you hold the licence at those dates.

FRENCH CJ: Now, how does that interact with subsection (3) in respect of a non-public transmission company?

MR STEWARD: The interaction is the timing. The order had to be made before the licence was transferred to the privatised entity. Your Honour will see it says at the commencement of the order:

The [Order] in Council . . . declares that the amounts payable as an impost . . . as the holder of a licence –

PNV. But the draftsperson knew, at the time this order was made, two things, your Honour. Firstly, the asset sale agreement had already been entered into, and, secondly, the completion was about to take place, which is why we see these - - -

FRENCH CJ: Sorry, what I am trying to understand is how does the order continue to apply once the licence has been transferred to a non-public transmission company?

MR STEWARD: Your Honour, the answer is that subsection (3) provides a power to make the order and then that power is turned off, effectively, after privatisation. But the order can continue to exist, having been made prior to the act of privatisation.

FRENCH CJ: Of course, you have made a promise not to challenge the validity of the order, I think.

MR STEWARD: I will come back to that.

FRENCH CJ: Yes.

MR STEWARD: There may have been some concern that it looked like an excise, but I will return to that.

FRENCH CJ: Well, there might have been a concern about its interaction with subsection (3).

MR STEWARD: I cannot answer that, your Honour. There is no evidence about that, unfortunately. Now, as it happens, the possibility of a transfer of the licence to a privatised entity was not only clear because the asset sale agreement had been entered into, but the language of the end of the Order in Council contemplates that it might have been transferred again. That is why it goes to the trouble of making sure that whoever is going to be the transferee has to be someone who will undertake to pay it.

NETTLE J: But you would have remained bound by your covenant in the agreement to pay it in any event, would you not?

MR STEWARD: No covenant in the agreement, your Honour.

NETTLE J: No promise to pay?

MR STEWARD: No promise to pay. I will come to that; no promise. Just on that, as it happened in the year 2000, ownership of the appellant did change. There was not a sale of the business but there was a sale of all of the shares. There is a finding of that at paragraph 6 in the judgment of the learned primary judge.

FRENCH CJ: It was GPU to SPI, was it not?

MR STEWARD: Yes. Now, we respectfully submit that the contingency – that is that you had to be the holder of the licence – was sufficient to deny the presence of a present liability in 1997 when PNV, albeit only for a few days, existed – co-existed with this order, if you like. Could I invite the Court to go to the decision of this Court in James Flood [1953] HCA 65; 88 CLR 492, which appears on my learned friend’s list.

James Flood, it will be recalled, concerned the deductibility of a provision for holiday and sick pay which had not yet been taken up by various employees. The deduction was denied on the ground that it had not yet been incurred. The liability was fully accrued but this Court identified that there existed a number of contingencies which might intercept, to use the language of the Court, the accruing right of the employee to take holiday and sick pay. If I could invite the Court to go to page 504 of the judgment to the second paragraph, and there is a passage about seven or so lines into that paragraph commencing “Now in dealing with that instrument”, their Honours say:

it is necessary at the outset to observe that under the award an employee may fail to become entitled to annual leave for a number of reasons. He may die, his employment may be terminated . . . From the employer’s point of view there is a further possibility. He may never become liable to give his employees two weeks’ leave on full pay because he may sell his business . . . It may be true that all these reasons which, so to speak, would intercept the accruing right of an employee to be paid by the taxpayer are all of a particular character, but it is difficult to say in the face of them that there is a definite obligation to make a payment, incurred in respect of each completed month –

The reason why we have taken the Court to take passage is because in James Flood the possibility of the sale of a business was sufficient to deny a present liability. It was a contingency which ensured that the future liability remained contingent. We rely upon that because of the contingency here that you had to be the holder of the licence. The liability to pay the impost could be intercepted, to use the language of James Flood, by selling the transmission licence.

It follows from what we have just said – and with great respect to Justice Edmonds below – that his Honour was incorrect when he reasoned that PNV had a present liability prior to completion, which was then assumed by the taxpayer appellant. Nothing was assumed in 1997 because there was nothing yet to be assumed. Liabilities were in the future.

GAGELER J: But James Flood is a case about the application of the word “incurred” in section 51 of the Act as it then stood.

MR STEWARD: Absolutely, yes.

GAGELER J: It is not suggested here that the liability that arose under section 163AA was incurred at the time of the order being made.

MR STEWARD: My learned friends submit that.

GAGELER J: I see.

MR STEWARD: Yes, they do. Could I next turn to another document, being the information memorandum which was given to all bidders. There are three or four important passages in that information memorandum which I need to draw to the Court’s attention, both for the purposes of the negative limb contentions and also for the positive limb contentions and it is convenient to do it now rather than take you back to it later on.

The information memorandum appears at appeal book volume 1, page 66. Can I first ask the Court to go to page 80 - that is using the page numbers for the appeal book rather than the information memorandum. You will see about point 7 there is a heading “Incentive Based Regulatory Regime”. There is a useful description in the following paragraph of the MAR and the X factor, but the first sentence of the next paragraph is what I would like to draw to the Court’s attention. It says:

As the CPI-X regulatory regime applies to PowerNet’s revenue and not its profits –

and then, if I could take the Court to go to page 99, you will see in the middle of the page – and I draw this to the Court’s attention now for we will need to return to it – following from about point 3 onwards, there is a description of what the revenue cap is calculated to reflect. This sets out the composition of the calculation. It relates to “efficient levels of operating and maintenance costs”, “a return on capital”, and “straight line depreciation”. I draw that to the Court’s attention now because that was very much relied upon by the learned primary judge for her Honour’s conclusion that there was a distribution of profits, rather than a payment of gross revenue and I will turn to that.

KIEFEL J: When her Honour referred to profit, she was talking about profits after tax, was she?

MR STEWARD: The answer is, we think, yes. We think that like the United Energy Case, which we will come to, her Honour concluded that the payment came out of a fund which had already borne income tax. But we disagree with that.

KIEFEL J: At page 80, when this memorandum says “revenue and not its profits”, the profits it is referring to are net profits after tax? It must be because revenue is otherwise just income, is it not?

MR STEWARD: It is not clear. I will show your Honour some pro forma accounts in a minute with would tell you exactly where the imposts lie in terms of it being before or after tax. I will come to that in a moment. Could I then draw the Court’s attention to pages 101 and 102? On 101, at paragraph 2.4.2, there is an explanation of the imposts in dispute in this matter:

It is intended that an Order will be made pursuant to section 163AA . . . imposing the following specified charge . . .

The specified charges will be fixed amounts and payable quarterly in arrears for each financial year . . .

It is intended that the charges . . . will not be imposed from 31 December 2000.

Then it goes on to say – there is a diagram at paragraph 2.4.3. We provided to the Court, and I do not know whether it reached your Honours, a colour version of that diagram - I am indebted to your Honour. Your Honours will see the way the impost works in the diagram. We have a heading “PowerNet’s Revenue” and we say “gross revenue” and I will come back to that. You will see that the bit in blue is the actual revenue, the bit in black – on mine at least, anyway – is the corrected MAR, or maximum available revenue, and the yellow bit is the bit they have to take away because it is too high. We can see then at paragraph 2.4.4 the explanation:

The Tariff Order currently specifies that an X-factor of 1.79% will apply to 31 December 2000. PowerNet’s revenue caps have effectively been reset through the licence fee –

that is the imposts –

and the new X-factor for 2001 and 2002. This approach to re-setting the revenue caps was adopted:

(a) due to constraints imposed by the Maximum Uniform Tariffs which the DBs –

that is distributors –

can charge franchise customers and which currently apply to consumers without revision to 31 December 2000; and

(b) to avoid any windfall gains accruing to PowerNet and its customers which may result from the re-set.

That is the explanation of why the impost is there, and this is given to all the bidders, so they all know why they have to pay it. But note there is no mention of the impost being consideration for the sale of the transmission business. Bidders are told that the source of the liability is the Order in Council and section 163AA. There is no mention of it being part of the bargain that will be negotiated or reached between bidders and the State; it is just a given.

It is a necessary part of the regulatory regime which any winning bidder must subject themselves to if they are successful. Nor is there any suggestion here that the means of securing the correct regulatory MAR is to be by way of a sharing or distribution of profits, or surplus, or any net figure. Certainly, there is no suggestion that the payment is to be a payment out of taxable income, as that term is defined in the Act.

We can see – and your Honour Justice Kiefel, this addresses the question you asked me earlier – where the impost is to lie if we go back to page 79. There is a table 1.1, which sets out summary, pro-forma, historical and forecast financial results. We will see there a profit and loss statement. We can see the prescribed revenue flowing in, excluded revenue and other revenue; “Other revenue” is a reference to the fact that not all the sources of revenue of the owner of the transmission business was by prescribed services. They had other sources.

One then sees the licence fee, the impost, operating as a reduction, or a deduction from the gross prescribed revenue. It is sitting there tellingly with operating expenses, which also reduce gross revenue, and the net result is the statement of EBDIT, Earnings before Depreciation Interest in Tax. Here, there is an unequivocal representation to bidders, that the impost is going to be a means of reducing your gross revenue, and it is going to happen, just like your expenses, before we get to the fund of profits upon which you can distribute dividends, as the law then was, or the taxable income of the company.

MR STEWARD: There is another version of that, if it matters – and if I ask the Court to just take a note at page 161. There is one final matter I want to draw the Court’s attention to at page 210. At the paragraph in the middle of the page, “A5.3 Transmission Licence”:

PowerNet’s Transmission Licence was issued by the ORG pursuant to the powers in the Electricity Industry Act. The licence is not exclusive.

The licence is not exclusive. That stands in contrast to the position of the distributors during this time, which is described in the United Energy Case, which we will come to. For distributors, in Victoria, following privatisation for five years each distributor had a statutory monopoly over a geographic area for the sale of electricity. The United Energy Case held that the fee paid in that case was for the benefit of that exclusivity – that statutory monopoly. We do not have a statutory monopoly. True it is one can infer readily, that we have what must be called a natural monopoly by economists because we have just bought the transmission network but we do not have a legal monopoly.

FRENCH CJ: The acquisition of the licence was subject to an approval was it not, by the regulator?

MR STEWARD: Yes. The approval process, I think, is set out in section 161 of the Act, 161 and 162.

FRENCH CJ: Yes.

GAGELER J: The whole point of having a MAR is to regulate the pricing of what would otherwise be a monopoly supplier.

MR STEWARD: No, your Honour, I cannot agree with that. That may represent a possible economic justification for it, but one must bear steadily in mind a distinction between, on the one hand, the economic justification and then the means adopted to resolve or secure that object. The whole point of the MAR is that the means adopted was a reduction on gross revenue, not a sharing of profits. That is the point.

Could I now turn to the assets sale agreement, which of course is the source of my learned friend’s identification of the liability and which may or may not be thought to contain a covenant to pay it. It appears in the appeal book volume 2 at page 391. Now, confessedly, of course, both Justice Gordon at first instance and Justice McKerracher agreed that it did contain a promise. Justice Edmonds did not say it contained a promise. His Honour said it was bound up in the total purchase price. Could I take the Court to the main operative provision, clause 2.1. It is at page 402:

Subject to the terms of this agreement, on the Completion Date:

(a) the Seller must sell . . .

(b) the Buyer must . . .

(1) buy . . .

(2) assume the Creditors –

and there is a provision that addresses that which I will take your Honours to, and –

(3) pay the Total Purchase Price –

The term “Total Purchase Price” is defined earlier on page 400 about point 7:

“Total Purchase Price” means $2,502,600,000 –

and following that there is a description of it –

being the sum of the price of the Assets . . . net of Contract Liabilities and Creditors . . . assumed –

Now, the Commissioner argues before this Court for the first time that the creditors there include the State of Victoria because the Order in Council was made before completion and created a present liability on PNV. Now, for the reasons that I have already sought to articulate, there was no such present liability. There were future liabilities and your Honours will see that the type of creditors referred to in the total purchase price are only those which are assumed. The clause which addresses the assumption of liabilities is clause 7 which appears on page 408:

Following Completion, the Buyer assumes with effect from Completion all liabilities of the Seller –

Pause there for one moment. Of course, it is not a real assumption. We need to read that as a promise by the buyer to indemnify the seller for the liability because there is no novation here. But what is sought to be assumed are the liabilities of the seller. PNV, for the reasons that I have already submitted, had no present liability. It also had no future liability to pay the imposts because it was selling the transmission licence by this agreement. It was not going to be the holder of the licence in 1998, 1999 or 2000. So we do, with great - - -

BELL J: SPI in turn might have sold the licence.

MR STEWARD: Yes, of course. So we do, with respect, disagree with the proposition that the total purchase price includes the impost liability, but we can see that in an even more manifest way, if I could direct the Court’s attention to the recitals.

FRENCH CJ: Incidentally, the definition of “creditors”, does that have any significance?

MR STEWARD: On my learned friend’s case it does. Your Honours will have seen it is a very broad definition.

FRENCH CJ: Including contingent.

MR STEWARD: Yes, but not future and contingent and, your Honour, total purchase price does not encompass all creditors, just creditors assumed.

NETTLE J: Are not all contingent liabilities future and contingent?

MR STEWARD: On one view, yes, that may be so.

NETTLE J: You do covenant to bear the contingent liabilities when they come home, do you not?

MR STEWARD: No, we read clause 7 as saying we covenant to bear the liabilities then existing. The language of clause 7 is slightly at odds or different to or more narrow than that broad definition. If we could turn to it momentarily:

the Buyer assumes with effect from Completion all liabilities of the Seller –

It would be odd, your Honour, if the parties had intended that we would bear the future liabilities of PNV that did not exist or pre-exist the sale of the business, a highly uncommercial arrangement. But we can see – if I could return to the recitals – we can actually see the bare bones of the bargain reached between the buyer and seller in great clarity.

NETTLE J: Just staying with clause 7 - - -

MR STEWARD: Yes, your Honour.

NETTLE J: You agreed to pay all Creditors – capital “C” – as the Chief Justice points out, that includes contingent creditors. Is it not a promise to pay them when they come home, when and if they come home?

MR STEWARD: No, your Honour, because it – as my learned friends point out, it is a liability of the seller. The seller is PNV and PNV will not have that liability in future years, ever, because it has entered into this assets sale agreement to sell the transmission licence. It will not be the holder.

NETTLE J: Whether or not it has the liability it has extracted from you a promise to pay it when and if it comes home.

MR STEWARD: It has to be a liability of the seller, a liability that the seller will have, and we know for a fact from this agreement that PNV will never be liable.

NETTLE J: I do not want to delay too long, but does not the seller at the point of sale have a contingent liability to mean the licence fees when and if they come home?

MR STEWARD: No, your Honour, it does not. For the reasons of the language of the Order in Council, the liability is a future liability payable at those future dates to the person who is the holder of the licence on those dates.

NETTLE J: Thus, if it sells it, it will not have to bear it, but before so it has the contingent liability to pay, does it not?

MR STEWARD: If it is the holder of the licence, but by this agreement it will cease to be the holder of the licence.

KIEFEL J: But it is a liability but for the agreement.

NETTLE J: Yes, albeit contingent, a contingent liability which you agree to bear.

MR STEWARD: We do not read clause 7 in that way. We would think it a bit odd to read clause 7 – well, I withdraw that. It may be your Honour is right that contingent liabilities arising from the business which PNV held in October 1997 are covered by this promise. But the way we read the agreement is that would not include the liabilities created by the Order in Council.

FRENCH CJ: The Order in Council came into existence about a week before transfer.

MR STEWARD: Yes, yes.

FRENCH CJ: So, it came into existence while PNV was the holder of the licence.

MR STEWARD: In a sense, your Honour, we may be labouring on a point that may not matter too much - - -

NETTLE J: I think you are right - - -

MR STEWARD: - - - because, as you will see, we submit that we still – even if there is a promise - - -

NETTLE J: I understand that point. That is a different one to the one which you were just putting.

MR STEWARD: Yes, of course. But can I invite your Honour to look at the recital, because clause 7 would need to be read in the context of the recitals and recitals E and F do, with respect, set out the bare bones of the bargain in quite unequivocal terms. I should say the accuracy of E and F has never been challenged. It is not suggested that they are some form of misstatement of the true bargain. You will see E says:

The total value attributed by the parties to the sale of the Assets . . . the subject this agreement is –

$2.5 billion. It then says at F:

The parties agree that the total payments to the State in connection with the privatisation of [the seller] are $2, 732.500,000 (including –

future liabilities of 177,500 – that is the imposts – as discounted to 161. Now, the point we get from that is clear and obvious. If the total purchase price included the imposts, recital E would say so, but recital E does not. Recital E says the bargain is you pay $2.5 billion for the assets and in addition, separate to that are the imposts, candidly paid in connection with privatisation, no doubt about that, but they are not paid for the assets. That is covered by the purchase price of $2.5 billion.

KIEFEL J: But they are paid for the business, are they not?

MR STEWARD: No.

KIEFEL J: But you do not get the ability to conduct a transmission business unless you pay the fee.

MR STEWARD: Correct. All successful bidders would subject themselves to the payment of the fee; we will come to it in a minute. This agreement contains clauses designed to better secure its payment.

KIEFEL J: But are you not paying for a right, then? It might not be an asset, but you are paying for something that enables you to conduct the business.

MR STEWARD: Your Honour, in our respectful submission, there are two things to bear steadily in mind. The first is that if this agreement contains a promise to pay the impost, or even if it does not, there can be no doubt that from the perspective of the seller, the State, the State was telling bidders you have to pay both if you want to be the owner of the licence, unquestionably. That is from the perspective of the State. From the perspective of the purchaser, which is how we must decide this question, recitals E and F tell you that they have made a payment for the business, $2.5 billion – that is the correct sum payable for it – and they have to make another payment, and the question becomes, and we will address this shortly, what is that payment for? What is the advantage secured by it?

KIEFEL J: No, the $2.55 is for the assets.

MR STEWARD: That is the assets, yes.

KIEFEL J: You just elided that with business. They may be two different things.

MR STEWARD: I did not intend to do that, and I apologise if that is the impression I gave. The reason why it refers to assets, of course, is because that is what is generating the value; the assets generate the cash flow of the business. I am indebted to Ms Deards - there is a definition of “assets” which your Honour will see towards the end of the page, 395, which contains a whole series of things, including the licences in subparagraph (f).

We do not deny that in order to be the successful bidder you have to pay both sums. The question is can we confidently say that the second sum was also paid for a capital advantage, capital assets, of which the definition contains many, or is it for something else?

Can I then turn to more directly address the question of whether this agreement contains a promise or a covenant to pay the impost? Below, there were two groups of provisions which were said to be the source of possible promises to pay. The first is clause 4.3, which appears from page 404.

FRENCH CJ: I am sorry, just before you leave the recitals, I suppose it is important to maintain the legal distinction between the seller and the State. The seller is that to whom the total purchase price is paid. The State is that to which, defined as the Treasurer, the imposts are paid.

MR STEWARD: Yes, and we adverted to that in our submissions. Of course, they came back and said the State is a party to the agreement, which it is undeniably, but it is of some significance for our case that the imposts are paid not to the vendor, but to the State, and to consolidated fund.

FRENCH CJ: But that leaves open the question, is the impost a necessary payment for the acquisition of the business, albeit that it is not part of the purchase price paid to the seller?

MR STEWARD: Your Honour, if I may address that question now by going to what I think is the nub of the matter. From the perspective of the purchaser there is no doubt a causative relationship between the suite of promises or the suite of liabilities – if I may use a more neutral term – which it has extracted from the person buying the business. Both of these are things that were required. If we were here dealing with the Duties Act, following on from this Court’s decision in Lend Lease, we would say both form part of the dutiable value. That is so.

But what the decisions of this Court tell you in cases like – and I will come to them shortly – Cliffs International and Morgan – is that from the purchaser’s perspective, even though the payment is a condition of sale, it must be made – it has a causative relationship – even though it does, from a practical and business point of view it may nonetheless not be for the capital asset because there is present another promise that does that work. Here, that promise is to pay the total purchase price. That is the thing which does the work from my client’s perspective of moving the assets, not the impost as well. But, I will take the Court to Morgan shortly, if I may.

We were at clause 4.3 on page 404. These set out a series of conditions precedent which, in our respectful submission, do not impose a contractual liability to pay but, rather, are designed to ensure that the regulatory regime whereby the liability can be imposed upon the holder of the licence is better secured. So that we can see in (a):

the State, the Seller and the Buyer shall procure that the Office of the Regulator-General approves the transfer of the Transmission Licence . . .

(b) the State shall procure the publication in the Government Gazette of an Order in Council declaring that the Buyer is a transmission company . . .

(c) the State shall procure that clauses 7 and 15 . . . are passed and proclaimed;

(d) the State shall procure the publication in the Government Gazette of the Licence Fee Order –

“Licence Fee Order” is defined as the impost, the Order in Council. Then -

(e) the State shall procure that the Deed of Amendment . . . set out in annexure I is executed –

None of these things convey, with great respect, a contractual promise to pay.

NETTLE J: Surely they import an implied promise at least to attempt to achieve what is provided.

MR STEWARD: They go so far as assisting in the machinery whereby the liability can be imposed. But, in the context, your Honour, where there already is an instrument imposing the liability it would, in our respectful submission, be wrong to imply a further contractual promise. We can see that working, your Honour, in the warranties which are also relied upon in clause 13.3(d) – if I could take the Court to that on page 412.

NETTLE J: Just before you do. Why is so important for you to establish that these do not import implied promises?

MR STEWARD: Because, your Honour, it enables us to submit that the source of the liability is a tax, a special tax, and being a special tax there is no exchange or bargain whereby we pay it for something. We just pay it and get nothing.

NETTLE J: But does it detract from your case that you may have made a promise in advance to pay the tax when it was imposed?

MR STEWARD: Only in the forensic sense deployed by my learned friends who say that that promise is one that is made for the transfer of the business, the assets.

NETTLE J: But if the payment is for a tax then it is for a tax, is it not?

MR STEWARD: We would submit so, your Honour, yes.

NETTLE J: So does it matter then if there is an implied promise to pay the tax when it is imposed?

MR STEWARD: It may not, your Honour, and it does not in terms of our second proposition which is that even if there is a promise it is still a tax and we do not get anything from it.

FRENCH CJ: What happens if you do not pay it?

MR STEWARD: If you do not pay it you would lose the licence.

FRENCH CJ: Is that a statutory consequence?

MR STEWARD: It is, your Honour. I do not think the material is before you but there is - - -

FRENCH CJ: Where does that appear?

MR STEWARD: If I take you to the transmission licence to try and deal with that and I can perhaps after lunch hand up to the Court the relevant provision. At page 931 in volume 3, your Honour, you will see paragraph 3.4 deals with the power of revocation. I do not think this is in dispute but perhaps it is. If you do not comply with an enforcement order it can be revoked. Then clause 18 makes it a condition of the licence that you “comply with all applicable laws” – that is on page 937 – so that the law would include the Order in Council. Then the term “enforcement order” is defined on page 940:

“enforcement order” means a provisional or final order made and served by the Office under section 35 of the Office of the Regulator-General Act 1994 –

It is that section which is not before the Court, but if my memory serves me it provides that if you are in breach of a condition of the licence – and here that would be clause 18 – they can give you an enforcement order which, if you do not comply with, will lead to revocation.

GAGELER J: Is a charge under section 163AA made a debt to the State?

MR STEWARD: I think so, yes, your Honour. By reason of the words in the Order in Council authorised – yes, when it falls due because of the word “payable”.

FRENCH CJ: Well, it comes out of section 163AA(2). That is the primary source, is it not?

MR STEWARD: Yes, your Honour.

GAGELER J: But is it simply enforceable as a debt?

MR STEWARD: Yes, and if not enforceable as a debt could be enforced by threatening to take away the licence.

GAGELER J: But are there machinery provisions in the State legislation that govern the recovery of that debt?

MR STEWARD: Not to my knowledge, your Honour. We will endeavour to check.

GAGELER J: There is no other provision of the Electricity Industry Act or of any other State legislation that makes explicit that it is a debt?

MR STEWARD: I cannot answer that one way or the other, I cannot assist your Honour, I do apologise.

FRENCH CJ: Is there any contractual consequence if you fail to pay the impost?

MR STEWARD: Not in our respectful submission, no. Could I then return to clause 13.3?

GAGELER J: I am sorry, if we are going to the source of the liability to pay, how do you put it?

MR STEWARD: We put it in two ways, your Honour. We say the source of the liability to pay is the Order in Council as authorised by section 163AA, and that is how the dissenting judge below, Justice Davies, found it to be. Alternatively, if the asset sale agreement contains an express or an implied promise to pay it, that is the source of the liability, or the more proximate source of the liability. Either way, paying this tax does not secure to us a capital advantage.

GAGELER J: Well, the second way is a contractual liability, liability at common law in contract. The first way is what, in your submission?

MR STEWARD: It is a statutory debt created by reason of the Order in Council, like the payment of any tax.

GAGELER J: So you have to put it as a debt?

MR STEWARD: Yes. When the Commissioner of Taxation sues people under the Income Tax Act, he sues in debt. He then produces to the judge the notice of assessment which is conclusive evidence of the due and correct making of the assessment, and he recovers.

GAGELER J: It is just by the way, really, that it is also a breach of the licence, not to pay.

MR STEWARD: It would depend upon the financial position of the holder of the licence at that time as to which of the remedies would be invoked. Clause 13.3, page 412, subparagraph (d) is the second source of the potential promise to pay. The first part of (d), number (1), provides that:

the amounts to be payable by the Buyer –

and we do attach significance to this –

pursuant to the Licence Fee Order –

not pursuant to this contract –

are an integral part of the regulatory framework of the industry and the Buyer accepts that it must pay the amounts set out in the Licence Fee Order –

Pausing there, in our submission, no promise to pay is conveyed there. Indeed, it would be inconsistent with the identification of the source of the liability, being the licence fee order, for wanting to go further and say there is a further promise; unnecessary to go so far. Number (2), on the next page –

the Buyer must not challenge the validity of the Licence Fee Order –

Your Honour the Chief Justice adverted to that earlier. We do not have evidence before the Court as to what the concern was; we will just have to infer it. I infer an excise, no more than that. Number (3) is where we get the closest thing to a promise to pay –

the Buyer agrees to pay to the Treasurer the amounts specified in the Licence Fee Order in accordance with the terms of, and at the times specified in, the Licence Fee Order, whether or not the Licence Fee Order is valid or enforceable –

Now, the way we read that is that that creates a conditional liability or promise to pay in the event that the licence fee order is invalid. This has expanded the remedies available to the State to collect the licence fee order. But importantly, from our submissions, if that promise had been activated – and it never was – what would have been paid would not be the licence fee impost we paid here, because the premise of (3) is that they are invalid, but rather a different sum, albeit in the same amount and payable at the same time, but it would not be the licence fee order itself.

FRENCH CJ: Well, it is whether or not the licence fee order is valid or enforceable. The premise is not that it is invalid.

MR STEWARD: We do read it as that is the premise. We acknowledge that those words are used, but when you read it in the context of (1), identifying that the source of the liability is the licence fee order, the only work that (3) could do in addition to that liability would be if the licence fee order had fallen over, which there was some concern that it might. Then, (4) is important as well:

the Buyer may not transfer the Transmission Licence or allow any person to become a licensee under the Transmission Licence unless the proposed licensee has first delivered to the State a covenant –

So here there is a covenant that must be conveyed –

agreeing to be bound –

Now, of course, that did not happen, but we do rely upon (4) because again what (4) is telling you is that the parties contemplated that the licence may get sold. That is significant for us because if you sell the licence you avoid the liability to pay.

FRENCH CJ: It really is a promise to the State, is it?

MR STEWARD: Yes. Not to PNV. PNV – I do not think this is before the Court – but I think PNV disappeared shortly after the asset sale agreement. So much for the asset sale agreement, the question now becomes whether or not there is a promise to pay it or whether it is imposed by the Order in Council. What advantage does it secure for us? The way that we have submitted it in our written submissions is to suggest and submit to the Court that really, in our primary case, really the impost is just like the land tax that was paid in Moffatt v Webb.

Moffatt v Webb [1913] HCA 13; 16 CLR 120 was a case of a decision of this Court where land tax was paid by the owner of land who was undertaking a grazing business. It was a case under the old Income Tax Act (Vic), which provided a deduction in section 9. If I could take the Court to it. Section 9 is relevantly reproduced in the headnote:

(1) All losses and outgoings actually incurred in Victoria by any taxpayer in production of income . . . shall be deducted –

The issue was whether State land tax was deductable pursuant to that provision. The passage that I do want to take the Court to appears on page 130 of the judgment of Chief Justice Griffith. Firstly, at about point 2 of the page, his Honour the Chief Justice said:

The land taxed is the very land on which the business is carried on; and, as I have already pointed out, it is impossible to carry on the business of grazing on that land without paying the tax. It seems to me, therefore, that the tax falls within the words “a payment made wholly and exclusively for the purpose of the trade,” as construed in that case.

A third point made for the Commissioner was that land tax is capital expenditure. I confess that I am unable properly to appreciate that argument. The cases relied on in support of it were cases in which money of money’s-worth was paid or given as the price of something to be used in order to earn income. It is impossible to say that land tax is paid for the purpose of acquiring anything. It may secure the taxpayer against being disturbed in his possession, but it certainly adds nothing to his capital – some people might think it diminishes it.

In this case, as we have endeavoured to submit, the very purpose of the impost was to diminish the gross revenue of the taxpayer. That is why it is there. That is the work that it does. In our respectful submission, our primary case is that we fall squarely within Moffatt. Just like Moffatt where land needed to be held in order to carry on the business, we here need to have the transmission licence in order to carry on the business, and by reason of holding that licence – the very thing that helps generate assessable income for us in each year – the reason – the thing that is productive of income is also the very thing which creates the liability. This raises the very basis upon which Justice Davies below decided in favour of my client when her Honour said, at paragraph 107:

The obligation to pay the imposts flowed as a necessary consequence of holding the licence, so that the thing that produced the assessable income was the thing that exposed SPI –

the taxpayer -

to the liability discharged by the expenditure.

That language comes from the decision of this Court in Herald & Weekly Times which her Honour refers to and that case – Herald & Weekly Times – sought a deduction for payments of compensation in defamation. The question was whether they were deductible. This Court said that the very thing that created the liability, the act of publication, was the very thing that secured it assessable income and so they allowed the deduction.

FRENCH CJ: Incidentally, the position you put with respect to the sources of the liability – you put it really as a binary position. Your primary position is the statute. The secondary position is even if the contract does not matter. Would you accept – and I do not think it would make any difference to your argument – that the liability may be – there may be concurrent liability, statutory and contractual?

MR STEWARD: We have debated that possibility amongst ourselves. It will not matter for our argument. It is possible, but it will not matter.

FRENCH CJ: Well, for example, there might be a contractual route to enforce the liability. There might be a statutory route by reference simply to the statutory declaration.

MR STEWARD: Yes, that is right. That is why we put it that the agreement enlarged the possible remedies available to the State. We say it goes no further than that, but if it does, we still are in the territory of asking what the payment was for. Can I then address the second proposition now? Your Honours will have seen that what was deployed against the taxpayer below was the famous dictum of Justice Fullagar in the Colonial Case where his Honour said:

It does not matter how they are calculated, or how they are payable, or when they are payable, or whether they may for a period cease to be payable. If they are paid as parts of the purchase price of an asset forming part of the fixed capital of the company, they are outgoings of capital –

That is the dictum. In our respectful submission, we read that not as a test but as a description of the usual case. What is the test is set out by Justice Fullagar on the same page in the judgment when his Honour famously said:

The questions which commonly arise in this type of case are (1) What is the money really paid for? – and (2) Is what it is really paid for, in truth and in substance, a capital asset?

That is the test. Could I now take the Court to the decision in Morgan? Its reference is [1961] HCA 64; 106 CLR 517. Morgan concerned the sale of land. One of the payments the purchaser was required to make, in addition to a price of some £26,000, was a payment to the vendor to recompense it for that portion of the rates the vendor had earlier paid to the rating authority but which related to that part of the year in which the purchaser was to be the owner and occupier of the land. So there was at settlement a further payment made to recompense the vendor for those rates. The argument against deductibility appears at page 520 of the report at about point 4. Their Honours say:

For there are two opposed sets of considerations affecting the answer. Against the allowing of the deduction it is urged that the amount of the rates or other outgoings already paid by the vendors but apportioned to the purchaser forms an item of the total payment which the purchaser must make in order to obtain a transfer of the property, and if it is not strictly part of the consideration for the land, at all events it is a payment made as the fulfilment of a condition precedent to obtaining a transfer.

Pausing there, there is a clear recognition of a causative relationship by the Court of the fact that you had to make the rates recompense payment if you were going to get the land. That is part of the suite of promises that the vendor has insisted upon and which he will not give you the land unless you make. If the Fullagar dictum was the test, then you would conclude that the payment for the rates was on capital account, but this Court held that it was deductible, and one can see the key passage over the next page at 521 in the second paragraph, commencing at point 4:

On the whole the better view appears to be that the apportioned part of the rates does form an allowable deduction from the assessable income of the year covering the period to which that part is referable. Not only as a matter of reason and business sense is it an outgoing on account of revenue, but an examination of the grounds on which it is said to be capital and not incurred in gaining the assessable income discloses their inadequacy. In the first place neither under the contract nor under the statutory provisions –

and I pause there. There were statutory provisions in place which would make the purchaser liable for the rates in the event he did not pay them –

does the apportioned part of the rates really represent a payment for the land as a profit or income earning subject, that is as a capital asset. The price remains fixed. The payment of the apportioned part is separate –

That, with respect, is the nub of our second proposition. We are the same. The price is fixed, $2.5 billion, the imposts are a separate matter. They discharge a separate concern, namely, the regulation of the appellant’s maximum allowable revenue in the years following a sale. The two are distinct. So that we can see immediately that there is, on the one hand, an acceptance that in these cases there can be a causative relationship, that the promise must be made in order to get the business, but that is not the end of the inquiry.

One must go on and ask in the context what was it for, and inferentially, if you can identify another promise that was given or made that was adequately for the capital asset you are more likely to conclude that the second promise is for something else. You need to reach a conclusion whereby you are confident in all the facts with the result of characterisation which is that the imposts here are for a separate matter.

GAGELER J: So, if clause 13.3(d)(3) is a contractual obligation to pay, what is that for, in your submission?

MR STEWARD: We would submit it is still for no capital advantage. In other words, it is not necessary for me to identify that unlike – I will start again. In Morgan, it was for the rates. In Cliffs International, it was for the right to receive royalty income in the successive years; I will come back to Cliffs International. They are cases where the additional promise does secure an advantage and the question is, is it capital or revenue? This case is unusual because the promise, if it be one made, does not secure an advantage. Indeed, it would be antithetical to the whole regulatory regime if it did, because the purpose of the regime is to take away, not to give something back.

GAGELER J: It is a promise for consideration.

MR STEWARD: It is a promise to pay tax, and then the question becomes what advantage did you get by promising to pay the tax?

GAGELER J: That is the question I asked.

MR STEWARD: The answer is nothing, from my client’s perspective, nothing. Indeed, it would be odd if the answer was otherwise. When one looks back at the reason for the impost, the problem that was discovered, you are making too much gross revenue, we will need to take away some of that gross revenue and the means of doing that will be the payment of this tax. It would be odd if, as part of that, one were to conclude that you got something back.

GAGELER J: Do you have a fall-back position short of nothing?

MR STEWARD: No.

FRENCH CJ: You make a promise to pay whether the tax is lawfully imposed or not.

MR STEWARD: That is one way to read clause 3, yes.

FRENCH CJ: Yes, whether valid or enforceable.

MR STEWARD: Yes. We prefer not to read it that way, for the reasons I have given - - -

FRENCH CJ: That was not a problem in the rates case.

MR STEWARD: No, it was not.

FRENCH CJ: It may be, one does not know, you are saying “All right, well, whether or not this is a valid impost, we are going to pay it”.

MR STEWARD: Yes. But the question becomes, can we conclude that it was paid for the business, or for the assets of the business which generated the income, and when you juxtapose that promise, as your Honour the Chief Justice has put it, with the promise to pay the total purchase price.

KIEFEL J: But if you had not promised to pay it, you would not have had the business transferred to you?

MR STEWARD: Precisely so, same as in Morgan; if you had not promised to pay the rates, no transfer of land. Could I say something very shortly about Cliffs International? It will be recalled that in Cliffs International, an option was sold to buy shares in a company called Basic. The agreement for that option appears conveniently on page 145 of the judgment, 142 CLR. At about point 3, at clause 5 in the judgment of Chief Justice Barwick, it is said:

The Purchase Price referred to in Article 4 shall consist of an Initial Payment of TWO HUNDRED THOUSAND DOLLARS . . . plus Deferred Payments equal to 15c (US) per ton of Iron Ore payable –

What happened was at that time the company called Basic owned an exploration licence and it was very much unknown whether it was going to be successful in making a discovery of iron ore or not. As it happens, it was successful, not on the land - as it happens, that was the subject of the initial exploration licence but on land connected to it.

The taxpayer did not claim a deduction for the initial payment of $200,000 but did seek to claim a deduction for the deferred payments which arose in subsequent years. The question was whether those deferred payments were deductible. Chief Justice Barwick and Justices Jacobs and Murphy found that it was. Justice Gibbs, as his Honour then was, and Justice Stephen held that it was not.

Now, below, Justice Edmonds was somewhat critical of the judgment of the majority. It may be thought that the status of the authority is subject to question. It has certainly been debated a lot over many, many years. As it happens, I do not think this Court need decide this question today because my learned friends do not seek to suggest it was wrongly decided.

Moreover, it is explicable as a matter of principle, by reference to the Morgan decision. What most commentators have ended up describing Cliffs International as being is being a case where the deferred payments were not really for the option, but really for the subsequent exploitation of the rights held by the company in later years. That is how the case should be seen, having peculiar facts, special facts, and not being one which requires to be revisited in any great way. I should add we do rely in terms of principle on the passage which appears in the judgment of the Chief Justice on page 149, at about point 8, where his Honour says:

It is also true that its promise to make the payments in the events which occurred formed part of the consideration given for the acquisition of the shares. But they were acquired without making the payments in question. The recurrent payments were not made for the shares though it might properly be said that they were payable as a consequence of the purchase of the shares.

Whilst there is a sense in which the promise to pay an amount rated to the tonnage of iron ore extracted from the temporary reserves in events then contingent and uncertain could be regarded as part of the cost to the appellant of the shares, I cannot think that the payments when made, having become payable because of supervening events can properly be regarded as part of the purchase money for the shares in Basic. As I have indicated, the fact that the promise to make the payments formed part of the consideration for the transfer of the shares does not mean that, when made, they were paid for the shares.

That is, in a sense, another iteration of the Morgan principle which is that there may be a causative relationship between the giving of the promise and the capture of the capital asset, but nonetheless the promise is not made for that capital asset. In Cliffs International what was for the capital asset was the initial payment. There is one other passage I should refer the Court to which is instructive.

GAGELER J: Well, the word “for” then becomes quite elusive.

MR STEWARD: Yes, your Honour.

GAGELER J: If it is not consideration then what is it referring to?

MR STEWARD: The word “for” in this case?

GAGELER J: In this context in the passage in which you rely where a distinction is drawn between a payment that forms part of a consideration and a payment being for something.

MR STEWARD: The only way that we think it should be read is to make the broad distinction between, on the one hand, you have the concept of consideration which includes all those contractual promises that the vendor requires in order to move the asset. So in Lend Lease, the duties case, there were all those promises that were given in addition to the particular contractual consideration for each plot of land.

GAGELER J: I see, so it is severable consideration. It is a reference to a bundle of obligations being severable.

MR STEWARD: Yes, and, indeed, the passage I wanted to take your Honour to now addresses that very point.

GAGELER J: Yes.

FRENCH CJ: Just before you leave that question, a payment is for the acquisition if it is a sine qua non of the acquisition, that being a class which includes purchase price plus any other payments. Is that the sort of conceptual territory you are operating in?

MR STEWARD: I think it might be the opposite to that, your Honour, in the sense that a sine qua non relationship might be the starting point but would not be sufficient, a “but for” relationship would not be sufficient. You need to go on and ask, as this Court has told us, what, from a practical and business point of view, was it really for? If there is already a promise that is doing the job of being for the assets, and there is here, then the question will then become, well, what did you get from making the other promise.

In Cliffs it was the use of the rights, in Morgan it was the rates. Here, it may be odd to think of it, but it is very hard from our perspective to see what advantage, capital or revenue, we received by paying the imposts. We, with respect, see it very much like Moffatt v Webb where Chief Justice Griffith observed that the payment of the land tax achieved nothing for Mr Moffatt. Can I take you to that passage now, page 174 of the judgment of Justice Jacobs?

NETTLE J: Just before you do, at 151 in the third-last paragraph, do you put it that way? Do you put your case that way? It is part of the consideration – the promise is but the payment is not.

MR STEWARD: Yes, on my second proposition, yes. If there is a promise to pay that is contained in the asset sale agreement, then it does form part of those contractual promises that the State wanted, so it must be, but it is not for. Page 174, in the last paragraph, his Honour Justice Jacobs says, I think in about the fourth line:

The best known example is the lease for a term of years where the consideration is a premium and a rental. The premium is a capital outgoing, the rental a revenue outgoing. This can be explained upon the basis that the premium is the price of the initial grant and that the rental is the recurrent price of use and occupation. That is true but it does not gainsay the fact that the obligation to pay both premium and rental springs from the one agreement. It shows that out of one agreement may spring obligations to make payments some of which are capital outgoings and some of which are revenue outgoings.

That, in a sense, addresses your Honour’s observation about severability. The word I would use is “separate”. That is the word that this Court used in Morgan where the advantage, or thing obtained, is separate from the capital advantage obtained by the other promise.

GAGELER J: In a business and commercial sense, I think you said.

MR STEWARD: “Practical and business sense” is the phrase used from Hallstroms Case.

GAGELER J: Yes.

MR STEWARD: Your Honours, I have agreed with my learned friend, Ms Symon, that I will sit down at 12.15 pm, and that being the case with half an hour to go, could I now turn to the positive limb part of the argument? In the final sentence of paragraph 47 of the Commissioner’s submissions he submits the test is as follows:

The question is not whether the payments were, strictly, out of a fund called “profits” but whether they were made in the course of deriving profits.

For that purpose, my learned friends rely upon the decision of Justice Lockhart in United Energy. The first thing that divides us is that we submit that that expression of the test is not correct, but that even if it was correct, there were on the evidence here, no distributions of profit or surplus but, rather, gross revenue.

The correct test appears in the judgment of this Court in a case called Midland Railway Company of Western Australia 85 CLR at 306, but could I first take the Court to the judgment at first instance of Justice Kitto which was reported at 81 CLR at 384? Midland Railway concerned some debentures and then some reversionary certificates that replaced those debentures and the certificates could be redeemed out of the net profits of the company.

So, one of the submissions that the Commissioner made in Midland Railway was that when they were redeemed in 1943, there was no deduction allowable because there was, effectively, a distribution of net profits which is the proposition that our friends contend for here. If I could take your Honours to page 393 of the judgment of Justice Kitto? In the first paragraph, at about point 3, point 4:

It was further contended for the commissioner that if this conclusion should be reached, expenditure in redeeming such reversionary certificates is not an allowable deduction, because it is a payment out of net profits after they have been ascertained and the directors have determined to divide them.

Reference is then made to a decision of this Court, in Boulder Perseverance and an English decision known as A.W. Walker. Now, before we go on, there are two things I need to point out. Firstly, Boulder Perseverance was a case concerning the Dividend Duties Act (WA), which imposed tax on profits. The English cases to which reference is made also imposed tax on profits. The Income Tax Assessment Act does not. The Income Tax Assessment Act imposes tax on taxable income, which is assessable income less allowable deductions. Justice Kitto goes on:

In my opinion these cases do not require the conclusion that a payment of interest on money borrowed for the purposes of a business, when the contract under which it is payable makes the profits of a business the exclusive source for its payment, is to be held on that account not to be an allowable deduction under s. 51 . . . To say that it is payable out of profits or even out of net profits, is not to say that it is payable out of taxable income. Confusion may easily arise from cases dealing with the question whether particular payments are to be regarded as made in the course of ascertaining profits or out of profits when ascertained, because of the different senses in which the “profits” may be used.

There is a reference to some more decisions about profits. Now, pausing there, the test which Justice Kitto articulates there is that it does not matter if it is payable out of profits. What matters is whether it is payable out of the fund called taxable income. We can see that this is approved as the test when the decision went to the Full Court of this Court and if I could your Honours firstly to page 313 of the report at volume 85? This is in the judgment of Justice Dixon, as his Honour then was. At the top of the page, in the first full sentence:

Further it is not decisive of the issue under s. 51(1) that it was paid or payable out of profits, that is so long as it was not payable out of the precise fund called by the Act taxable income.

Now, two things emerge from that statement of principle. One, there is an implicit recognition that “profit” is not the same as “taxable income”. What is a profit now under Australian accounting standards would not be the same as the fund of taxable income taxed by this Act. There is a whole range of reasons for that. The Act contains all sorts of capital allowances, for example, that are designed to encourage particular types of activity. An example is you get an upfront deduction for exploration expenditure. In the year in which we are concerned with here, you got a 125 per cent write-off for research and development expenditure. These things stand in contrast to what might be the commercial concept of a profit, or indeed the Australian accounting concept of a profit in 1999, 2000 and so on.

The second thing that you get out of the proposition is that it only matters if the payment is made out of a precise fund, not a fund that is akin to taxable income, not a fund that is roughly like taxable income, but precisely the same fund as taxable income. Whilst we are with Midland Railway, could I remind the Court that at page 321 in the last paragraph, Justice Webb adopted the same test:

I am inclined to think that all three expressions –

that is, surplus revenue, net profits, surplus profits –

are inter-changeable, as they are used in these transactions . . . but in any event none of the three expressions is identical with “taxable income”. If they were identical, then money paid for the redemption of a certificate, even for a certificate originally issued to a debenture holder, could not be an allowable deduction –

Now here, it is not suggested that the imposts were paid out of the taxable income of the appellant. Rather, reliance is placed upon the decision of Justice Lockhart in United Energy 78 FCR 169. Could I take the Court to that now, and make two observations about it? This case concerned a fee paid pursuant to section 163A – not AA, but A. It was payable by the distributor companies during the five years in which they held a statutory monopoly. The question was, was it deductible?

Justice Lockhart held that it was not deductible primarily because his Honour found that it was a distribution of profit, the case put by my learned friends. Justices Sundberg and Merkel decided that the imposts were not deductible because they were really for the statutory monopoly. They were consideration for the statutory monopoly which we do not have here. I will give the Court a reference to the passage where that is best said. It is on page 193, at about point 6.

Now, the first observation we wish to make about Justice Lockhart’s decision is his Honour does not refer to the test in Midland Railway. The case is not mentioned. His Honour refers to the decision of Boulder Perseverance, an English decision which was a profits case, but his Honour does not refer to Midland Railway. All we can say about that is that we, for our part, have seen the submissions the Commissioner put to the Court. They do not refer to Midland Railway. We have not been able to recover the submissions that the taxpayer put, so we do not know whether his Honour was aware of the decision or not. All that matters for the moment is that his Honour did not refer to it and thus did not ask the correct question, which is, was the payment paid out of taxable income? He asked that different question: was it a distribution of profit?

The second thing to observe about United Energy is that the impost in that case was dramatically different to the one here. In other words, whilst we think Justice Lockhart’s reasoning may have a problem with it, we do not dispute that the result is correct in that case. Could I invite the Court to go to page 176 of the judgment, where Justice Lockhart has conveniently set out the terms of 163A. You will see that subsection (1) provides that:

A distribution company that holds or has held, an exclusive licence under this Part authorising it to sell electricity to franchise customers –

They are the customers over which they had a monopoly –

must pay to the Treasurer, in respect of each financial year during which it holds, or held, such a licence the impost determined in respect of that year by Order of the Governor in Council, on the recommendation of the Treasurer –

Then, subsection (2) is where the nature of the impost is then explained:

The Treasurer, in recommending the amount of an impost for each financial year payable by a distribution company, must be satisfied that the amount reasonably represents the amount by which the income of that company derived from the sale of electricity to franchise customers in that year is likely to exceed the sum of:

(a) the costs of deriving the income; and

significantly -

(b) taxes payable in deriving that income –

So, one can immediately see two things about the 163A impost. One, it is seeking to extract a net surplus figure, not a gross amount. Secondly, it is seeking to extract it from funds which have already borne tax. Thus, the conclusion reached in that case was correct – namely, that this should not have been an allowable deduction because this was a payment out of a fund that had already borne tax. It was not incurred in gaining or producing the tax because the tax had already been paid.

That, of course, is very different to the position here. Our section 163AA has no equivalent to what is contained in subsection (2). That leaves for consideration the judgment of the learned primary judge because the learned primary judge was very much aware of the Midland Railway test. There is no question about that. Her Honour nonetheless decided that imposts were not deductible because they represented a distribution of profits after tax.

The error that we think her Honour made, and we say this with profound respect, is in essence this. The error is that her Honour conflated the economic justification for the calculation of the impost with the particular means adopted of extracting it, and even then, we respectfully submit that the economic justification was misunderstood.

FRENCH CJ: An impost under 163AA can be formulated or calculated on a variety of bases including criteria of the kind perhaps one sees in 163A. The section is simply silent on the basis upon which - - -

MR STEWARD: It is silent but not silent on the means of extraction.

FRENCH CJ: Yes.

MR STEWARD: The means of extraction on the payment of fixed amounts, and your Honour will recall a representation made to bidders that they would be payments reducing revenue because at the end of the day we are talking about a mistake that was made in the calculation of the maximum allowable revenue and an impost that is intended to reduce that revenue. There is nothing in the information memorandum or in the terms of 163AA on its face or in the Order in Council that is equivalent to what we see in (2) which is a much more complex arrangement after tax.

FRENCH CJ: The payments are to be made at such times and in such manner as are specified, so one goes to the order for that.

MR STEWARD: Yes, precisely so, there is nothing in the order about it. The order does not use the language of saying that you must pay a percentage of profits, it does not say you must distribute your profits to the State, and indeed, and this is of great significance, the payments must be made whether or not you have any profit. You could be in losses but still be liable to pay those fixed amounts. You just have to pay them.

So that even if the proposition is, as my learned friends put it, this is really a distribution of profits, factually that is incorrect. The nub of Justice Gordon’s reasoning, if I may take the Court to it now, appears at paragraph 73 of the judgment. It is at page 999 of the Court book, volume 3, and it is the first paragraph. Her Honour says there:

But the revenue cap in the Tariff Order was not limited to derivation of PNV’s assessable income. The revenue cap in the Tariff Order was calculated to reflect three matters – efficient levels of operating and maintenance costs, a return on capital and straight line depreciation at rates reflecting estimated useful lives . . . The charges were set to enable PNV to recover the cost of its assets over time . . . to provide it with a return on capital (using the Optimised Depreciation Replacement Cost value of assets multiplied by a weighted average cost of capital) and to recover its estimated operating and maintenance costs –

Pausing there, all of that information is set out in the information memorandum at the page I took the Court to earlier; I think it was page 99 in volume 1. There are two things that we would say about the means by which the amount to be extracted was calculated. Firstly, the three things there referred in (a), (b) and (c) are not the same thing as the precise fund for the taxable income as a taxpayer. Secondly, there is no indication in those three paragraphs that the impost would be paid following the payment of income tax by the taxpayer. Indeed, the expressly opposite representation is made in the pro forma accounts on page 79, where the imposts appear before the line item, Earnings before Depreciation Interest in Tax.

FRENCH CJ: As you say, the statute read with the order imposes a liability which you simply have to pay. It does not matter how you work it out internally.

MR STEWARD: That is right. That is the nub of it. It is not a sharing of profits or a distribution of profits; it is simply a payment you have to make.

GAGELER J: Whether or not you are actually using the assets?

MR STEWARD: Yes, as long as you hold a licence. If you are still holding the licence, and you are not using the assets to produce income, you still have to pay it.

NETTLE J: It would not be deductible in that case, though, would it - Ronpibon.

MR STEWARD: Your Honour, it might not be. It depends on how long you were dormant, as it were.

NETTLE J: Yes.

MR STEWARD: Going back to Justice Gordon’s judgment, though, for one moment, the nub of where her Honour reaches her Honour’s conclusion is in that last sentence of paragraph 73. Her Honour said:

Those elements necessarily included calculations of PNV’s taxable income – revenue less estimated operating and maintenance costs and depreciation.

With great respect to her Honour, we do not think that is right factually; they do not. There is no evidence to suggest they do not, and indeed, in the Full Federal Court, that is precisely what Justice Edmonds said. There is no factual foundation for that proposition. The reference in Justice Edmonds’ judgment was at paragraph 6, appeal book 3, page 1026.

Your Honours, we are travelling very well. I only have two more things to say. Firstly, when my learned friends filed their annotated submissions last week they attached to them seven extracts of evidence. This Court must know that those extracts were not before the Full Court. They were before her Honour and her Honour makes findings about them which I will not need to go to yet because I will see how they are deployed but, for the moment, the Court should know that we do object to the course of conduct taken whereby my learned friends made a decision about the composition of the appeal book before the intermediate appellate court. They made a decision about the composition of the appeal book in this Court and are now seeking to avoid the choices that they have made in the litigation by attaching the extracts to their annotated submissions.

As it happens, we do not consider that the extracts can assist the Court because, of course, what they do not give you is the full evidence. So, for example, they have given you two pages out of an expert report – they do not give you the cross-examination of the expert, and so on.

NETTLE J: Just the accounting treatment?

MR STEWARD: Both the accounting treatment – and I will say something about that very briefly, perhaps – but also another topic – some internal documents that were not shown to the appellant which the primary judge held were not part of the matrix of facts upon which she decided the case. She said they were irrelevant.

Can I just say about the accounting position? The taxpayer did not expense the impost in its accounts. There was unchallenged evidence that there was an incentive for it not to do so because if it expensed it, it would have depleted its reportable profits instead of amortised it. The expert evidence before her Honour was that the Commissioner’s experts said that was correct. The taxpayer’s experts said it was incorrect. Her Honour declined to decide which of those two experts were correct because as her Honour correctly decided, the question posed by the accounting standards is not the question we have to address here. It is an irrelevancy.

This Court has adverted to, on a number of occasions, that commercial practices and accounting practices will often be divergent from the tax result. The most recent example of that in this Court was the CityLink Case.

NETTLE J: You have not mentioned CityLink yet.

MR STEWARD: I have not.

NETTLE J: Are you going to?

MR STEWARD: I can if your Honour wishes me to.

NETTLE J: Not at all. If you think it not too relevant to your case, I am pleased not to have to live with it.

MR STEWARD: It may need to be adverted to by me, depending on what my learned friend says, but not for the moment.

NETTLE J: I mean CityLink in this Court, not in the Federal Court.

MR STEWARD: Yes, yes. I think that is all I wanted to say about accounting evidence. Yes, I am indebted to my learned friend, Ms Deards. I was quite wrong when I said that the public transmission company is not defined in section 163AA and I apologise to the Court. It is defined in section 3 of the Electricity Industry Act to mean a transmission company, which is a statutory authority or a company, all the shares of which are held by, or on behalf of, the State or a statutory authority. Thank you.

The last thing I wish to say simply by way of background and touching upon the need to look at this from a practical and business point of view is that it is well to remember, as we have already observed, that if the State of Victoria had the ability to reduce the MAR in 1997 we would not be here today. There would be no assessable income and no deductions. Instead, the State created the impost as the means of reducing the MAR, which it did.

If the Commissioner is correct, the fiscal consequence will be at odds with the whole point of the regulatory exercise. That is because the appellant has been assessed on revenues which exceeded its MAR, that is the yellow bit in that diagram which, as a practical and business reality, it has not been able to keep and enjoy. If we are correct, the fiscal consequences will align themselves with the practical and business reality that this was MAR that we had to give back.

GAGELER J: I am going to ask it anyway. I have probably asked it already but does your case in relation to clause 13.3(d)(3), if it is read as imposing an obligation, come down to saying that from a practical and business perspective that obligation was assumed for nothing?

MR STEWARD: It was assumed so that there would be a promise to pay the tax imposed by the Order in Council and paying that tax, the whole point of paying that tax was not to confer on the appellant any advantage. It was to reduce its MAR and no more. In that case, it is quite unusual because Morgan was a case where you could identify an advantage. So was Cliffs International but in this case, you cannot. It is like Moffatt v Webb where Chief Justice Griffith said the point of the tax was to diminish your position, not add to it. If the Court pleases, those are our submissions

FRENCH CJ: Thank you, Mr Steward. Yes, Ms Symon.

MS SYMON: If the Court pleases. The respondent says that the Full Court correctly decided that the payments in question were outgoings of capital. That is the issue on the appeal and by the notice of contention the respondent contends that the payments were not deductible in any event, relying, as my learned friend has said, on the reasoning of Justice Lockhart in the United Energy Case, that reasoning being, and his Honour’s ultimate conclusion being, that the payments in question were not outgoings incurred in gaining or producing its assessable income or necessarily incurred in carrying on its business. That is the question his Honour was asking, not what was the source of the payments.

But coming to the issue on appeal first, in our submissions, we essentially take three approaches to the issue on the appeal and each of those approaches yields the answer that payments were outgoings of capital. I am briefly going to outline each of the approaches and then take the Court to the facts and circumstances on which of those approaches relies.

Firstly, we say that by the asset sale agreement correctly construed, the appellant assumed liability for the payments as part of the purchase price for the assets, as outlined in our submissions at paragraph 12. That means when the payments came to be made, they were clothed with the character of capital. In that, we draw the analogy with the Colonial Mutual Case at submissions 13.

That was a case where the purchase price for land comprised an undertaking to make payments over 50 years in exchange for the transfer of the land. The promise to pay was, in essence, the price, and appears – and it was clear on the face of the documents, as his Honour Justice Fullagar found in the famous passage at 454, that the undertaking to pay and the payments when made were paid for the land. There was no need to go behind the documents.

NETTLE J: But the payments here were not made for the land or the licence, were they?

MS SYMON: They were made for the assets or for the – we say, forming part of the price, the assumption of the liability to make the payments was, as a result, paid for the assets, that is - - -

NETTLE J: Promise was given for the acquisition.

MS SYMON: Yes. The price comprised three elements: a monetary amount – two elements - a monetary amount and the assumption of the liabilities in respect of the creditors. The assumption of the liabilities in respect of the creditors included the obligation to make the impost payments and forming part of the price was therefore a payment on capital count, being part of the price for the assets.

NETTLE J: The reason I ask you is because of the distinction Chief Justice Barwick draws in Cliffs between the promise to make the payments and the payments. The promise is the consideration, but the payments are not part of the consideration. They are for the use of the asset thus acquired.

MS SYMON: Yes, your Honour. That is why we took our second approach, as Justice Edmonds did below, and said is there anything beyond the contractual document, that is, the strict construction of price in this contractual document which might yield a different answer, just as in Cliffs, as your Honour has pointed out, the promise was part of the consideration, but ultimately it was found that the payment was not made for the assets.

So that second approach mirrors the approach of the plurality in Cliffs and in our submission again we say there is nothing in the wider circumstances which justifies a different conclusion than that given by the strict construction of price in the assets sale agreement. That wider examination of the circumstances is, at paragraph 14 of our submissions – it supports the conclusion that the payments were a cost of acquiring the transmission assets, not paid for the subsequent use of the assets.

NETTLE J: That will not live, will it, with Chief Justice Barwick’s analysis in Cliffs. Granted the promise to make the payments were part of the consideration for the acquisition of the assets, the payments are not made for the assets. The payments are made for the use of the asset thus acquired.

MS SYMON: In our submission not. That was the result in Cliffs, your Honour, but it is not the result here on an examination of the facts and circumstances here. Cliffs International turned on its own facts. What we mirror in Cliffs International is the process the Court undertook, that is, the Court there found it necessary to go behind the documents, that is the documents which expressed payment as part of the consideration, and test that out.

The answer in that case was that properly examined on the facts of that case the payments in question were ultimately in the nature of a royalty. That is not this case. In this case the further examination of the facts, and I will come to them, and particularly the machinery of the asset sale agreement, does not require a different answer than the assumption of the liability to make the payments forming part of the price. If one goes behind the strict construction of price, one comes up with the same answer. The difference between this case and Cliffs is when one went behind the strict construction of the documents one got a different answer.

Then our third and final approach leaves aside the asset sale agreement. Even if the Court disagrees with our construction of the asset sale agreement, as our learned friend has, a source of the payments, it is our submission that the history and context for the payments indicates that they were an integral part of the regulatory framework for the electricity industry in that they were a mechanism adopted to adjust the regulated revenue of the transmission company to ensure that the newly privatised business would enjoy an appropriate return in its initial years.

In this, it is our submission, these payments mirrored the franchise fees the subject of United Energy and determined in that case to be on capital account because those payments were similarly a mechanism adopted to adjust the regulated revenue of the distribution companies at the time they were privatised.

So our point at respondent submissions 17 is that the payments were made for the profit yielding structure of a business, that is, they were made in the setting up or establishing of the business structure or organisation within which the appellant was to earn profits because the regulatory framework within which the business operated was a part of the business structure or organisation which was being established. They were not made as part of the process by which the organisation subsequently operated to obtain regular returns. The benefits, the advantages of making the payments are set out at respondent submissions 17.

If I could go then to the facts and circumstances to support those conclusions, I am going to go first to the regulatory background and the background to the payments which are most closely relevant to our third approach and the matters set out at respondent submissions 17. But we know, and it is not in dispute, that the payments were a mechanism for ensuring that the maximum allowable revenue earned by the transmission company on privatisation reflected an appropriate return on capital.

The maximum allowable revenue was set by the tariff order made under the Electricity Industry Act and in the case of the transmission system the maximum allowable revenue was set in respect of prescribed services. The tariff order is in volume 3 of the book at tab 5.4.1 and the definition of “prescribed services” is at page 811. The important thing to notice about the definition is that the prescribed services as explained in the box next to the definition at 3.1 – well, the revenue cap only applies to prescribed services. They are the core transmission business which PowerNet is licensed to carry under its transmission licence and they relate to the transmission system as of 3 October 1994.

So, when one comes to the definition of “prescribed services” itself there are two types of services described in (a) and (b) defined elsewhere. They are network services and connection services but, importantly, services relating to the system existing as at a particular date. Thirdly, there are services relating to the augmentation of the system, again existing as at that particular time and particular augmentations which are specified and foreshadowed by the tariff order itself.

These services, because they are tied to the transmission system as it existed at a particular time, are services which only PNV and then the appellant as purchaser of the transmission system could provide, that is, another entrant to the market could not provide those services because another entrant could not provide a connection to a part of the transmission system that existed as at 3 October 1994. Only PNV and the appellant could do that.

Now, my learned friend has taken you to some of this but if I could ask the Court to go to the information memorandum. I want to take the Court to context in which we put it. The regulatory framework was explained in the information memorandum and it explained that the - - -

FRENCH CJ: Which page are you taking us to?

MS SYMON: Pages 76 and 77 in the first instance. Your Honour, it is tab 5.1. In the first instance the information memorandum explains that the regulatory framework regulated the remaining monopoly elements of the industry of which transmission was one and the tariff order was part of that regulatory framework. One sees that from the paragraph beginning against line 40 on page 76 referring to the establishment of the Office of the Regulator-General and then refers to:

The economic regulatory framework adopted in Victoria provides for incentive based regulation of prices in the remaining monopoly elements –

one of which was transmission. Then, at page 77, again in the paragraph commencing against line 40, PowerNet, or the transmission monopoly:

is regulated by the provisions of the Electricity Industry Act, its transmission licence and the Tariff Order.

They are the whole of the regulatory framework and then goes on to explain the maximum allowable revenue, that is the existence of a revenue cap and its adjustment. What the information memorandum further emphasised was the predictability of the regulated revenues which comprised 95 per cent of the total revenues of the transmission company. Continuing in the paragraph at page 77, the Court will see the sentence:

This cap provides a high degree of predictability of PowerNet’s revenue from existing transmission assets over preset five yearly periods –

and currently to 31 December 2002. At page 80, the predictability of the transmission revenue is again highlighted in the heading at the top of the page, and this time the reader is told:

PowerNet derives a substantial portion (currently in excess of 95%) of its total revenue from its existing regulated transmission business.

Then, in the last two paragraphs of that page, the information memorandum noted the ability to earn greater profits by outperforming the cost assumptions which underpinned the regulated revenue. That is the last two paragraphs which my learned friend has already taken the Court to.

At page 97, the information memorandum also noted steps the government was taking to deliver predictable outcomes beyond the life of the existing tariff order, and to 2007 as regulation of the industry transitioned to regulation under what is there called “the Code”. It was what was to be a national code of regulation, and the Court will see about six lines up from the bottom of the page the reference to the government proposal:

to make amendments to the Tariff Order which will deliver more predictable transmission pricing outcomes through to December 2007 –

As we know, the maximum allowable revenue set by the tariff order was reviewed in preparation for privatisation. That is not in dispute and is set out in our learned friends’ statement of the facts; not because the government had made a mistake, but indeed in preparation for privatisation, there was a testing out of whether the assumptions on which the tariff order had originally been based had been correct, because of course, time had passed.

It was found that, with the benefit of hindsight, some of the assumptions had not proved to be correct and so there was a need for an adjustment to the revenues, because the maximum allowable revenues set under the tariff order could now be expected to yield an inappropriately high return on capital after operating expenses and appreciation. In other words, the transmission company’s profits upon privatisation would be excessive, and the section 163AA imposts were adopted as the means to address that part of a transmission company’s return on capital which exceeded the amount considered to be reasonable. The information memorandum contemplated and explained the payments, and my learned friend has taken the Court to the explanation at page 101.

FRENCH CJ: The legal character of the payment is unaffected by any of this. I mean, suppose we knew none of this and all we knew was that a licence order, the order under section 163AA had emerged from the Office of the Governor in Council. How does this - - -

MS SYMON: Well, except that it did not, your Honour, and section 163AA, as the learned trial judge pointed out, read on its face does not provide much assistance. It simply provides a power and then the Order in Council read on its face simply imposes a payment. This background, in our submission, is important and does have a lot to say about the character of the payment. Of course, it is important to look to all of the facts and circumstances in determining the character of the payment. These facts and circumstances are important because principally to the argument on the notice of contention, perhaps not so much on the characterisation - - -

KIEFEL J: Do not these facts go to what was sought to be achieved by the State in creating the impost?

MS SYMON: They do.

KIEFEL J: Does that assist us?

MS SYMON: In our submission, it does, particularly on the section 8-1(1) point, because what one sees in – well, it assists in two ways. On the notice of appeal point, that is, the characterisation point, this background is important and the explanation of the payments and how they came to be set is important as background to the asset sale agreement.

This explains the machinery in the asset sale agreement and, of course, what we are dealing with is a purchaser of the business who was well aware that the payments were going to be required and what they were designed to do, that is, as the passages at page 102 indicate, effectively reset the revenue cap, that is, the amount of revenue which the privatised company would enjoy and it would do it, as the diagram indicates, by extracting amounts which were now considered excessive following the review.

So, the background is important because it is explained to the purchaser and it is also important because one understands the integers in the calculation of the imposts and it is the integers in the calculation of the imposts which underpin Justice Lockhart’s reasoning in the United Energy Case. His Honour asked the question which is the question that one must ask under section 8-1(1) - are these payments made by the appellant in deriving its income?

His Honour found that they were not, because having regard to the way they were calculated they were not a payment out of profits, but they were a payment akin to a payment out of profits, or, he also put it on the basis that they were, in essence, a State tax on profits. The result – the path of reasoning finishes with, and that is why the payments were not payments made in deriving assessable income because – and the source of it is the manner in which they are calculated. I will come to that - - -

NETTLE J: But that was because, ultimately, they were a State tax on taxable profits, was it not?

MS SYMON: In our submission, it does not matter whether they are a State tax on taxable profits. The critical aspect in his Honour Justice Lockhart’s reasoning was the – and, perhaps, I will take the Court to it because this is really the nub of the 8-1(1) argument - - -

NETTLE J: I do not want to deflect you from your chain of argument.

MS SYMON: Well, the point I want to make, really, is this point on 8-1(1) and if I talk about it in the absence of taking the Court to the reasoning then it will probably be a waste of time.

NETTLE J: Very well.

MS SYMON: If I could take the Court to United Energy v Commissioner of Taxation (1997) 78 FCR 169? The critical passage is – perhaps before I go there, there are two matters by way of background. We say that Justice Lockhart’s reasoning can and ought to be applied here because as her Honour the learned trial judge found, the structure and imposition of the franchise fees and the payments here was the same. Her Honour’s reasoning found in that conclusion is at paragraphs 72 to 76 of her judgment at tab 7 of the book, volume 3, page 1000.

That is because each represented amounts which would be derived by the relevant licence holder, either the franchise – the distribution company or the transmission company, in this case - from the provision of the relevantly regulated services that were over and above all capital and operating costs after allowing for an appropriate return to shareholders. In our submission, the additional integer of allowing for amounts paid by way of tax in the United Energy Case does not make any difference. The amount to be extracted in each case represents amounts left after the taking into account of costs and return to shareholders.

So when one comes to Justice Lockhart’s judgment at page 180, the reasoning there can be applied equally to this case, because his Honour was not concerned with whether the franchise fees were in fact payable out of profits. His Honour was concerned with whether there the franchise fees were expenses or costs incurred in the derivation by the appellant of its income. The Court sees his Honour’s conclusion at the paragraph beginning against point F on page 180. His Honour’s conclusion is that:

the franchise fees are not in my opinion expenses or costs incurred in the derivation by the applicant of its income or in the course of carrying on its business from which it derived such income.

That is, his Honours is asking the statutory question which must drive the result, that is, do the payments fall within section 8-1(1)? His Honour indeed says it is unreal to regard the payment of these kinds of payments as falling within either of the two limbs of section 51(1) of the Act. How his Honour gets there begins at the paragraph against point C. In reaching his conclusion, his Honour had regard to the manner in which the fees were to be calculated. He said:

The amount of the franchise fees is ascertained by direct reference to the calculation by the Treasurer of likely income to be derived by the applicant. Doubtless the calculation by the Treasurer of that income is fairly close to what it is in fact because of the nature of the monopoly –

That is an important second element in his Honour’s reasoning. The calculation can be accurate. So the manner of calculation is important because the amount of the payments could be said to fairly represent excess profits, that is, what is taken as an amount that is over and above what is considered reasonable return on capital. So it is not the source from which the payments would be made that was decisive but what one learns about the payments from the manner of their calculation, and it is manner of their calculation which gives his Honour’s reasoning in paragraphs D and E, beginning at the third line in paragraph D:

The government surrendered its monopoly of the control of this industry but in return demanded through legislation . . . that the residual profit to be derived from the carrying on of the industry became its profit.

Properly analysed, the franchise fees are in reality akin to the State of Victoria taking a share of the profits –

So the difficulty with what our learned friends say and the difficulty with what happened below was that the courts went to look to see if this was in fact a share of the profits. That was not his Honour Justice Lockhart’s reasoning. His Honour Justice Lockhart’s reasoning was having regard to the way the amounts were calculated these payments were akin to the taking of the share of profits and it is because of that that they could not be said to be amounts which were paid in the course of the distribution companies, in that case we say transmission company, in this case deriving their income.

FRENCH CJ: The manner of their calculation was set out in section 163A.

MS SYMON: Yes, your Honour.

FRENCH CJ: The manner of calculation is not set out in 163AA. It could have been set out in the order but it was not. They simply specified amounts.

MS SYMON: That is the point of her Honour’s reasoning at paragraphs 72 to 78 of the judgment. She commenced, where your Honour the Chief Justice is commencing, with section 163AA and says that does not tell us much; is there anything else which would assist us in understanding whether these payments are in some way parallel with the payments considered in United Energy? Her Honour went to the background to find that, indeed, the manner of calculation of these payments was discernible from the relevant material and, indeed, known to the appellant. Indeed, my learned friend took the Court to that part of the information memorandum which explained the integers in the calculation of the maximum allowable revenue.

NETTLE J: Can I just ask you one thing? If a shopping centre fixes the rents it charges to its tenants according to its expectation as to the profits they will generate, does it make the rents any the less deductible in the hands of the shopkeepers?

MS SYMON: No, your Honour. That is because rent is inherently a revenue outgoing. There is no doubt about that. The difficulty with this case is – part of the difficulty with our learned friend’s reliance on cases like Morgan – in this case the question is what is the character of the payments?

NETTLE J: Well, it is a tax, is it not? That is its essential character.

MS SYMON: I am concerned with its character as capital or revenue. In our submission, tax might be the answer, but one would still need to go further and say if it is a tax, does it have the character of capital or revenue? Our learned friends are trying to say if it is a tax, that is the answer; tax is always on revenue account. We disagree with that.

NETTLE J: Well, as I understand the submission, it is on capital account, you would say, because it is calculated by reference to expected profits. Is that it?

MS SYMON: I am just not sure if your Honour’s question is sitting within section 8-1(1) or section 8-1(2). Are we talking about the character with the payments or - - -

NETTLE J: As I understand it, it is accepted that it is essentially a tax. The question then is it a tax incurred on revenue account or on capital account and as I understand the Commissioner’s submission it is that because the government computed the amount of tax by reference to its expectation as to the profits which would be generated it must be on capital account.

MS SYMON: No, your Honour, our argument is that it is because the government made the calculation in the way that it did that allows for one to see that the payment is essentially an extraction of profits and because it is akin to a payment out of profits then it is not a payment which can be said to be made by the appellant in deriving its assessable income. So that is the 8-1(1) point.

NETTLE J: Thank you.

MS SYMON: However, his Honour Justice Lockhart did also have something to say about the payments as a tax and it appears at point F at page 180. His Honour described the fees as:

compulsory exactions imposed by the Victorian government to extract a share of the applicant’s profits made rather than a cost incurred in the process of derivation of income.

So his Honour always makes that distinction, always comes back to the language of the section. They are not a cost incurred in the process of derivation of income because they are a compulsory exaction, and he concludes:

They are a State tax on profits –

So, his Honour, having regard to the way the payments are calculated, also says that the payments amounted to a State tax on profits. Our learned friends say this is a tax; we do not have any particular reason to disagree with that. If it is a tax, then it is a tax on profits and a tax on profits is not a deductible outgoing.

If I could take the Court to a passage in Inland Revenue Commissioners v Dowdall, O’Mahoney & Co. Ltd [1952] AC 401. That was a case in which the concern was the deductibility under English law of amounts paid for Irish taxes, and at page 409 in the paragraph beginning at about point 6 of the page, the court said:

taxes such as those now in question, namely, income tax, corporation profits tax and excess profits tax, are not according to the authorities wholly and exclusively laid out for the purposes of the company’s trade in the United Kingdom. Taxes such as these are not paid for the purpose of earning the profits of the trade: they are the application of those profits when made and not the less so that they are exacted by a dominion or foreign government.

So, the questions which were before the Court in Boulder Perseverance and Midland Railway do not arise. If one correctly starts with the manner of calculation and arrives at the conclusion – and, in our submission, it is the correct conclusion – that this is, in essence, a tax on profits because what is being extracted is an amount which exceeds an appropriate return on capital, then they are amounts which simply cannot be said to be paid in deriving income. It has nothing to do with the fund of taxable income or assessable income or the fund which comprises profits. The question is are they amounts which can be said to be paid in deriving income?

FRENCH CJ: That might be a convenient moment, Ms Symon.

MS SYMON: If your Honour pleases.

FRENCH CJ: The Court will adjourn until 2.15.

AT 12.44 PM LUNCHEON ADJOURNMENT

UPON RESUMING AT 2.15 PM:

FRENCH CJ: Yes, Ms Symon.

MS SYMON: Thank you, your Honour. Before lunch I dealt with our notice of contention argument and if I could return now then to the capital revenue argument. At the outset, I took the Court to some parts of the information memorandum that are relevant to that part of the argument and, in particular, the passages at 76, 77, 80 and 97, all of which go to the benefits of the regulatory framework of which these payments formed a part. Our learned friends say they got no advantage from making the payments. In our submission, that is not right.

We have set out the benefits in paragraph 17 of our submissions and, as emphasised by the information memorandum, they included the advantage to the purchaser of the business of being a monopoly provider, one who was, of course, to be regulated, but what was emphasised was the desirability of having the predictable revenues which arose as a result of the regulation and, indeed, predictable revenues which would comprise 95 per cent of the expected revenues of the business.

There was another advantage at this particular time, of course, because what the payment or the undertaking of the payment of the imposts did was to secure the passing of the transmission system into private hands. This was not just a transfer of assets. This was a very particular transaction that took the control of the transmission system out of the government hands and into private hands. Then, in looking more particularly at the asset sale agreement, in assuming the liability to pay the imposts – and I will show the Court shortly how that was done via the mechanism of the asset sale agreement – the appellant gained the advantage of the transfer of the assets, including the transmission licence, and using the language one finds in the Tata Hydro-Electric Case, the right and opportunity to carry on the business.

That is particularly relevant to your Honour Justice Gageler’s questions about the promises made in clause 13.3(d). They were promises made with particular reference to the licence fees which would be imposed – which were imposed – and one must ask what were those promises made for? One does not put promises into an agreement for nothing. The only possible answer can be that the liability undertaken by those promises was undertaken for the transfer of the assets, particularly the transmission licence and the right and opportunity to carry on the business which went with that transfer. If I could return to one - - -

GAGELER J: Ms Symon, is there any relevance in the circumstance that section 163AA was amended to take its relevant form by Act No 35 of 1997, the purpose of which was expressed to be to provide for the corporatisation and privatisation of PowerNet Victoria?

MS SYMON: In our submission, there is, your Honour, if your Honour is referring to the amendment in 1995. I think your Honour said 1997.

GAGELER J: I said 1997, yes.

MS SYMON: Well, we would go back a step and say that there is relevance to the amendment of section 163AA in 1995 – it was not amended, it was introduced in 1995 at about the time that this privatisation occurred, and so one can see in its introduction that the mechanism for the making of the adjustment via section 163AA and the Order in Council was introduced in order to facilitate the imposition of the payments.

The other thing which is relevant, of course, that there was an amendment because PNV was not originally to be privatised and so section 163AA had to be amended to take account – to give a power to impose payments of a liability on a transmission company. The 1997 question, I am not sure of, your Honour. It seems to - - -

GAGELER J: That was the amendment to which you refer, I think.

MS SYMON: Perhaps I am getting my dates mixed up. 1995 must have been the – yes, 1995 was the privatisation of the distribution companies. Yes, I am sorry, your Honour. I am mixed up. 1997 is indeed the relevant date, because this privatisation that we are concerned with occurred in 1997, and so now I am standing in the correct date, looking at the correct privatisation, the point remains the same. It is clear that the mechanism for the adjustment was introduced into the Act for the purposes of the privatisation. It grounds our point even further that this was all part of the regulatory mechanism, and a part of the regulatory mechanism which was integral to the privatisation and the sale of the assets.

FRENCH CJ: Just so I understand it, the 163AA was introduced into the Electricity Industry Act by the Electricity Industry (Further Amendment) Act of 1975 which was number 79 of 1995 but in subsection (3) reference is only made to distribution and generation companies.

MS SYMON: Yes.

FRENCH CJ: That is the non-application - - -

MS SYMON: That is right.

FRENCH CJ: - - - provision, and so the amendment introduced the reference to the public transmission companies.

MS SYMON: Yes, which when the section was first introduced in 1995, were not proposed to be part of the privatisation.

FRENCH CJ: Yes.

MS SYMON: So, the section had to be amended once it was decided that the transmission company would not, after all, remain in public hands but would be transferred into private hands. If I could take the Court to a different aspect of the evidence and the appellant’s bid? One of the points we make in relation to our second approach at paragraph 14 of our submissions is that the payments were contemplated by the bid price. The Court will see at volume 1, page 244, tab 5.1.2 – this is the page of the bid where the purchase price is set out and the Court will see the offer of $2.5 billion in paragraph 3.1 and that is the offer:

if a Licence Fee is payable by PNV –

and, again, the total consideration at the bottom of the box in paragraph 3.2 is also the consideration which will be offered on the assumption that the licence fee will be payable. Then paragraph 3.3 specifically accepts that the licence fee order will be made:

as specified in the agreed draft Asset Sale Agreement –

with one amendment. So it says:

If the State accepts the bid . . . the State will cause the making of an Order in Council under section 163AA . . . in relation to the Licence Fee –

The amendment to the proposed licence fee, one sees at paragraph 6.1 on the next page. There is a box in which some modifications to the terms of the sale agreement are set out and the fifth item is “Annexure G Licence Fee Order” and it amends it to read that the payment will be $37.5 million:

in respect of the financial year ending 30 June 1998 –

The payments as they were originally proposed in the information memorandum were $50 million in respect of the year ending 30 June 1998 and the modification is explained in Mr Keller’s evidence as being negotiated because the sale would occur after first quarter of the 1998 year. The relevant paragraph of Mr Keller’s evidence is paragraph 22 at page 62 of the book. So, unlike a strict tax, these payments were the subject of negotiation.

The terms of the bid and their particular reference to the licence fee also reflect a point made in Mr Cohen’s evidence, relevantly, paragraph 23, tab 5, point 4, page 779 – that is, that one option for making the necessary adjustment to the transmission business revenues was to extract a higher price for the privatised transmission business, one which the government did not pursue because it wanted to maintain transparency in respect of the regulated revenues.

NETTLE J: What do you get from that, Ms Symon?

MS SYMON: Two things, your Honour. Simply that the bid took account of the requirement to pay the licence fee, which again, particularly when one comes to the asset sale agreement and looked at in light of the asset sale agreement reflects that the payments are capital in character. It particularly is analogous with a point made in the Tata Hydro-Electric Case, where one of the bases of the reasoning was that the assumption of the liability in that case was taken into account in determining the price that would be paid for the business. Similarly here, by parity of reasoning, this is a relevant factor that points to the payments being of a capital character.

NETTLE J: If one calculates the premium he is willing to pay to have taken assignment of the lease, the premises on which he will carry on business by reference to the rent he must pay for those premises, it does not make the rent any the less deductible, does it?

MS SYMON: It does not, your Honour, but that is because of the point I was making before lunch – that rent is inherently an outgoing on revenue account. There would not be a question as to the character of that payment. There is a question as to the character of these payments, and because - - -

NETTLE J: I appreciate that, but - - -

MS SYMON: - - - that is the question, this is a relevant factor which points towards character - - -

NETTLE J: We have come to the nub of it; why is it any more relevant to the correct characterisation of the licence fees for the purposes of their deductibility than it would be for the correct – for the deductibility of rent? What is it in point of principle that draws a distinction between the two that makes the fact that one takes into account the amount of outgoings one will have to pay in calculating one’s purchase price? An irrelevant consideration for rent, but as you would have it, an essential consideration for the purpose of characterising the licence fees as to whether they are deductible.

MS SYMON: Well, I do not know if I am saying it is essential. All I am saying is that when one is dealing with the rental outgoing, there is no question as to its character. There is a question – the very question here is what is the character of these payments?

NETTLE J: Yes, this much I understand. The next question is, why is it relevant in determining its character that one calculates one’s premium by reference to the amount of account outgoings one will have to pay?

MS SYMON: Well, simply because of the reasoning in Tata Hydro-Electric is one answer, your Honour. The other is – well, I take your Honour’s point. I am principally relying on the reasoning in Tata Hydro-Electric and that at the end of the day that was one of the factors which took the court to its conclusion, that the assumption of liability there was – rendered the – brought the character of capital to the outgoings.

BELL J: Just before you move on, could you explain the significance of the adjustment in relation to the amount payable for the year ending 30 June 1998? That was an adjustment that took into account the date upon which completion would take effect.

MS SYMON: Yes. The significance is that a true tax would probably not be subject to negotiation. What one sees is that the amounts of these imposts were the subject of negotiation between parties and the subject of an amendment to the draft asset sale agreement.

BELL J: Is it in some way different to an adjustment on rates or some other impost of that kind?

MS SYMON: Well, in the sense that these payments were not necessarily apportionable and directly relevant to the use of the particular asset, the transmission licence over time. That is, what was stated in the information memorandum was that imposts would be imposed in particular specified amounts. The particular specified amounts were not stated with any particular background. They were not stated as being referable to a particular period of time, for example, rather than payable in respect of the year in instalments. Then when one comes to the negotiation between the parties there is a change negotiated.

NETTLE J: Justice Gordon made an express finding about this at paragraph 36 of her reasons, that the adjustment was downwards because the order did not take effect until the first quarter of the financial year.

MS SYMON: Yes.

NETTLE J: You accept that.

MS SYMON: And that derives from the evidence of Mr Keller to which I referred the Court.

NETTLE J: Does that make it any the less a tax? Inasmuch as the information memorandum assumed that it would incept at an earlier time, in reality it was not until later, so that there was an adjustment downwards.

MS SYMON: It may not, your Honour. As I said before lunch though, we want to be careful about labelling the payment as a tax. They may or may not be a tax; we do not mind if they are or they are not, but the difficulty with saying they are a tax is that our learned friends say if you say these payments were a tax then that gives you the answer. In our submission, it does not because a tax may be on revenue account and it may be on capital account. The example we give in our submission is stamp duty.

Our learned friends say we get nothing for the payment of this tax. Well, one gets nothing for the payment of stamp duty either, but there is no doubt that the payment of stamp duty is on a capital account not because one gets something for it but because when one looks – well, the answer is one does get something for it because it is part of the cost of the acquisition of the assets. That is, one is undertaking a transaction in respect of a capital asset, the State tax has to be paid in order to effect the transfer and because it is part of the cost of the acquisition it is a capital amount.

So if the payment is a tax, the question that the Court is concerned with, namely, is this revenue or is it capital, is not answered simply by labelling the payment a tax. One must go a step further and say what is the advantage gained by the payment of the tax and, in our submission, in the stamp duty example one can see the advantage gained by the payment of the tax. One secures the transfer of the assets and the payment of the tax is part of the cost of the acquisition.

FRENCH CJ: So does characterisation of the payment as a tax have any relevance at all to the characterisation of it as on capital revenue account?

MS SYMON: That is the point I am making, your Honour. One might label it - - -

FRENCH CJ: Yes, I am just making sure how far you go.

MS SYMON: Yes, exactly. The label does not give the answer to the question of characterisation. If I could come then to the asset sale agreement, there is no doubt that the payments were imposed by the Order in Council made under section 163AA. We say there is a second source of the payment, and that what is critical when one comes to the asset sale agreement is one sees that the payments imposed by section 163AA and the Order in Council was an integral part of the machinery by which the appellant, the first private operator, purchased the transmission business.

If I could start with the definition of “total purchase price” in the agreement; the agreement is at volume 2 at tab 5.2.2, and the definition is at page 400. In our submission, the appellant misconstrues the asset sale agreement in two critical ways. One is with regard to the definition of “total purchase price” and the other is with regard to the definition of “creditors”. The definition of “total purchase price” is, we would say, “total purchase price” there is a label at page 400 of the book, and it means a monetary amount, the $2.5 billion specified, which is:

the sum of the price of the Assets . . . net of Contract Liabilities and Creditors –

“Sum” does not mean the monetary amount which is the amount of the price of the assets. What follows the word “sum” is actually a calculation. There is the sum of the price of the assets, net of contract liabilities and creditors. The price of the assets and the total purchase price are not the same thing. The price for the assets reflects both a monetary amount, and by the words “net of Contract Liabilities and Creditors” the assumption by the purchaser of the creditors as defined. One sees that same notion of price comprising a monetary amount and the assumption of these liabilities in recital E. The same form of language appears in relation to the value attributed. It is the monetary amount, net of creditors and contract liabilities.

The assumption of liability itself is in clause 2.1 of the agreement, and what is required on completion date is that the buyer will buy the assets, assume the creditors and pay the total purchase price. We say that this notion of the price as a composite of a monetary amount and the assumption of the liabilities is reflected in clause 2.1. Indeed, our construction of clause 2.1 finds support with the terms of the agreement considered by Justice Gummow in TNT Skypak International (Aust) Pty Ltd v Federal Commissioner of Taxation (1988) 82 ALR 175. His Honour’s analysis of the agreement there before him is at page 187, beginning at the top of the page:

The transaction between the taxpayer and Ipec thus called for the “purchase” of the business as described.

At line 4:

That “purchase” (that is the putting of the taxpayer in the place of Ipec) was to be achieved by several steps. First, Ipec was to sell and the taxpayer purchase the assets.

That is reflected in this asset sale agreement in clause 2.1(b)(1):

Secondly, the taxpayer was to pay to Ipec the amount by which the value of those assets exceeded the liabilities.

That is, pay a monetary amount, reflected in 2.1(b)(3):

Thirdly, the taxpayer . . . undertook to Ipec that it would honour the liabilities in question –

which were amounts of accrued holiday pay –

and also indemnified Ipec against the claims of creditors in respect thereof.

So, the undertaking to honour liabilities is reflected in the asset sale agreement 2.1(b)(2), and there is indeed in this agreement, for what it is worth, an indemnity found in clause 14 at page 414 of the book. His Honour’s analysis of that and conclusions about that form of agreement follows:

These steps, taken together, effectuated the purchase of the business in question. As I have indicated, the only sum to become due and payable by the taxpayer was that provided for in the second step. There was no payment earmarked for use by the taxpayer in discharging any liabilities –

But, critically –

it follows from what I have said that it would be a distortion of what occurred to single out one of the three steps involved, the sum paid as the second step, and treat this as “the purchase price” in the sense of the only consideration moving from the taxpayer in connection with the acquisition of the business in question.

So, on that reasoning, looking at clause 2.1 subject to the definition of “creditors” to which I will come, this case sits with Colonial Mutual in the sense that the assumption of the liabilities – and once the Court sees the definition of “creditors” one will see that the liability to make these imposts was one of them – forms part of the price and is therefore part of the consideration in fact exchanged for the transfer of the assets, just as in Colonial Mutual, on the face of the documents, the undertaking to make payments in the future was part of the price and manifestly made in exchange for the capital assets. The other thing that is important to notice about clause 2.1 is the opening words:

Subject to the terms of this agreement, on the Completion Date –

the purchaser assumes the creditors. That is not the same as assuming those who are creditors on the completion date, as our learned friends would have it. The term “creditors” is differently defined, and the definition is at page 397, beginning at line 30. “Creditors”, first of all, is defined in the present tense. It means:

all persons to whom are owed amounts –

So, in our submission, the definition defines as the pool of creditors who will be assumed those who fall within the meaning of the definition at the time the agreement is signed. There is no reference to the completion date here. Then, importantly, as the Court has already noted as my learned friend made his submissions this morning, the relevant creditors are those –

to whom are owed amounts [either] currently –

that is, as at the time the agreement was signed –

or prospectively or contingently –

Now, the timing of fixing the pool of creditors, in our submission, really does not matter. If the Court disagreed with our construction and said we have to look at who are the creditors on the completion date, it would not matter because the critical part of the definition is that it picks up creditors who are in prospect and creditors to whom amounts might be contingently owed.

FRENCH CJ: Just so I have got the sequence correct in terms of the dates, the earliest date for completion as I understand the definition of “completion date” was 6 November, but it could have been later because of the necessity to meet certain conditions precedent.

MS SYMON: Yes.

FRENCH CJ: And the imposition order was dated the 28th and published on 30 October.

MS SYMON: Yes, your Honour. That brings me to the other important aspect. When the agreement was signed, PNV’s liability to the State in respect of the payment was in prospect, and indeed, on the completion date, the liability to make the payments was in prospect or contingent as well. What is particularly important about that is the condition precedent, because what this agreement did was not only provide for the assumption of liability, but it provided very particularly for the assumption of this liability by specifically requiring that the Order in Council, that is, the licence fee order be in place as a condition precedent to completion. The Court has seen that in clause 4.3(d), the requirement that before completion:

the State shall procure the publication in the Government Gazette of the Licence Fee Order –

The licence fee order was set out in full as annexure G to the agreement. It is at page 579 and the Court has seen its terms. Importantly, it names PNV as the party on whom the liability will fall – PNV, indeed, as the holder of the licence, but it is important that it names PNV in the context of this assumption of the liability by the purchaser. The licence fee order does not merely name the holder of the licence from time-to-time.

We would also ask the Court to notice more generally that the conditions precedent, including paragraph (d), all reflect regulatory matters which had to be attended to before the transmission could pass into private hands. So, the Court has already seen the condition precedent in clause 4.3(b), the requirement that there be a declaration that the buyer is a transmission company for the purposes of the Act, and importantly, of course, the requirement that the necessary steps be taken for the transfer of the transmission licence. We note that the formal transfer or delivery of the transmission licence at completion is provided for in clause 4.2(c)(1) further up page 404.

The other thing we would ask the Court to note about clause 4.3(a) is that the transfer of the transmission licence is to take effect from the date of completion. One sees the same form of words in clauses 9.1 and 7 at 408. Clause 9.1 deals with transfer of licences generally. The definition includes the transmission licence. Again, the transfer is to be made with effect from completion. Similarly, clause 7, which deals with the assumption of liabilities, the buyer assumes, with effect from completion, all the liabilities of the seller to creditors.

So, although clause 4.3(a) requires transfer of the licence before completion, the transfer does not take effect until completion. So, the liability for the section 163AA payments remains with PNV until completion and the purchaser’s liability to make the payments in place of PNV is taken up on completion. So there is no gap, as our learned friends might suggest, because they contemplate that there will be a transfer of the licence before completion and on completion PNV will not have any liability.

FRENCH CJ: It will not have any liability because it ceases to be a transmission company because it ceases to hold the licence.

MS SYMON: Well, in our submission, that is not the effect of the agreement.

FRENCH CJ: No, I am talking about the statutory scheme.

MS SYMON: Well, yes. Under the Order in Council, PNV would cease to have a liability but that is the point - - -

FRENCH CJ: Well, “transmission company” means PowerNet Victoria while it continues to hold a licence to transmit electricity issued under Part 12.

MS SYMON: Yes.

FRENCH CJ: Once it ceases to be the holder of a licence – I see, yes. The order made still does apply to it.

MS SYMON: Well, it may not, but the critical aspect of what is established by the asset sale agreement is machinery for the assumption of the liability and - - -

FRENCH CJ: I am just wanting to understand the operation of subsection (3) here of section 163AA that:

An Order made under this section does not apply to . . . a transmission company . . . that ceased to be a . . . public transmission company . . . before the Order was made.

Now, in fact in this case it was still a public transmission company when the order was made because it was still the holder of the licence and also shares owned by the State.

MS SYMON: Yes, indeed, your Honour. That section is important because, of course, that is why it was necessary that the order be made before – one of the reasons it was necessary the order be made before the completion date because there was no opportunity to make the order once - - -

FRENCH CJ: You could not apply the order to a private licence holder?

MS SYMON: Well, one could not make the order in respect of a private licence holder.

FRENCH CJ: Why not?

MS SYMON: It might have been argued that one could not apply the order to a private licence holder. That means that the last term of the order which purports to impose the liability on a transferee of the licence might not have been effective. Section 163AA(3) certainly says one cannot make an order after privatisation - - -

FRENCH CJ: Well, I am not sure that it does.

MS SYMON: - - - but it does not necessarily limit the terms of the order but the terms of section 163AA(3) might call into doubt the validity of - - -

FRENCH CJ: It only dis-applies the power to make orders in respect of public transmission companies that cease to be such before the order was made.

MS SYMON: Yes.

FRENCH CJ: It seems to be silent on the question of a new entrant who becomes a licence holder.

MS SYMON: In the sense of taking a transfer of the licence?

FRENCH CJ: Yes.

MS SYMON: It does, your Honour. All I am saying is that because it is silent it may be that that final clause of the order which purports to have the liability run with the licence might be open to question. Whether it was or not, we do not know, but it may explain some of the machinery in the asset sale agreement and again the importance of the liability being assumed by the asset sale agreement and the purchaser agreeing to be bound to the licence fee order in any event.

Certainly section 163AA(3), in our submission, when one reads section 163AA and foreshadows this machinery of the sale agreement, the section was evidently made for the purposes of privatisation and we would also ask the Court to notice section 163AA(4) which gave the government owned transmission company the ability to pay the imposts before privatisation, that is it did not limit the party on whom they were imposed to making the payments on the specified dates. We would say that gave some flexibility in the privatisation process either the government owned transmission company could pay the impost before privatisation or the liability could pass to the private purchaser.

The other thing, of course, that one might note in relation to section 163AA(3) is that it appears to have been drafted on the assumption that the purchaser would acquire the shares in PNV. If the Court goes to the front page of the information memorandum and the first page of the explanation, the Court will see that what was being offered was a sale of PowerNet Victoria. Of course, what ultimately transpired was an asset sale agreement, not a sale of shares, but a sale of shares would not have necessitated a transfer of the licence.

So then, returning to the asset sale agreement, I have taken the Court to clauses 7 and 9 and made the point that really the machinery established by the asset sale agreement for the creation of the liability in PNV and its assumption by the purchaser was complete because there is no gap in the timing. What one sees, particularly from clauses 7 and 9 is that, leaving aside clause 2.1 and the assumption of the liability there, which we say form part of the purchase price, the agreement also contemplates that the liability will be assumed by the acceptance of the transfer of the transmission licence. That is because the machinery of the asset sale agreement required the liability to be imposed before completion so that the liability passed with the transfer of the transmission licence.

So, that really goes to our second approach, in paragraph 14, that there are two avenues which point to the payments being payments on capital account. One, they form strictly part of the purchase price, so the case is on all fours with Colonial Mutual – there is no need to go behind the terms of the agreement to see what the payments were for, because they form part of the exchange for the assets. If one looks a little more widely, even into the agreement, one sees that it establishes a machinery by which the purchaser, in accepting the licence, also accepts the liability which is required by the agreement by the time of completion to run with it.

That is reinforced by recital F and clause 13.3(d), which deal very particularly with the imposts, and again bind the purchaser separately from the impost of the Order in Council. So recital F requires – notes, firstly, that the payments are made –

in connection with the privatisation of –

the seller. In our submission, that connection acknowledges them as payments of capital because the privatisation is part of the establishment of the capital structure within which the business will operate. The second thing to notice about recital F is that the payments are referred to in their total amount, that is, when they are referred to the reference is to –

future licence fees of $177,500,000 –

and also the recital refers to the payments –

in net present value terms at approximately $161,000,000).

In our submission, that recital in that way is really treating the payment as a capital sum payable over time, rather than a periodic obligation, again pointing to them as payments of capital. We also notice that the total payments to the State of some $2.7 billion comprise both the total purchase price figure, that is, the monetary amount payable for the assets under the agreement and the payments in question. So here the payments are forming part of a total value to be contributed in order to achieve the transfer of the assets into private hands.

Finally, of course, there is clause 13.3(d), which contains a good deal of language which is particularly instructive as to the character of the payments. The clause begins at page 412 of the book; (d)(1) firstly, acknowledges the payments to be:

an integral part of the regulatory framework –

We know that the tariff order was the primary regulatory mechanism. It regulated the revenues of the transmission company, and we know that these payments were adopted as the temporary mechanism for regulating the appellant’s revenues, so the payments were not made in the course of the regulated business, but rather formed an integral part of the regulatory framework. In that paragraph (1), the buyer further acknowledges and specifically accepts that it must make the payments –

in order to carry on the Business –

of operating the transmission system. It must make the payments in order to carry on the business, not merely in carrying on the business. The payments are again positioned as payments which must be made in order to have the benefit of carrying on the business. Paragraph (2) prohibits the buyer from challenging –

the validity of the Licence Fee Order –

and paragraph (3) is an agreement by the buyer to make the payments –

whether or not the Licence Fee Order is valid or enforceable –

that is, the buyer submits to be contractually bound to make the payments if the licence fee order is enforceable, and if the licence fee order is not enforceable. That is what the words “whether or not” do, and the presence of those words make our learned friends’ contention untenable. It simply cannot be said that the contractual provision is only operative should the order be found to be invalid.

The other thing that clauses (2) and (3) disclose is some preoccupation with the validity of the licence order, which again helps one understand the asset sale agreement’s machinery for assumption by the purchaser of the liability to make the payments under section 163AA(3). Arguably, as my learned friend suggested, the Order in Council imposed an excise, or a special tax, to be borne by a single citizen, and it might have been thought subject to challenge. That makes clause 13.3(d) particularly important because one sees both in 13.3(d)(3), in the assumption of liability in clause 2.1, in the condition precedent in clause 4.3 that requires the impost order to be in place before completion, the establishment of a separate source of the liability for the payments.

NETTLE J: Just quickly, what does it add, that there is a separate source for the payments, from your perspective?

MS SYMON: I suppose the importance is this separate source, your Honour, that the source of the payments is now found in the asset sale agreement so the payments – the obligation to make the payments is now an integral part of the cost of acquiring the transmission business.

NETTLE J: As I said, the promise to make the payments are part of the consideration for the acquisition of the business.

MS SYMON: Yes, your Honour. So that when the payments come to be made they are clothed with the character of capital.

NETTLE J: Thank you.

MS SYMON: Clause 13.3(d)(4) is also important:

the Buyer may not transfer the Transmission Licence . . . unless the proposed licensee . . . agreeing to be bound by this clause 13.3(d) as if it were the Buyer –

So, any new licensee would also become separately, contractually bound to make the payments because it, too, would be required to assume the liability – the State would not be left with reliance on the licence fee order.

It is also important, in our submission, to reinforce 13.3(d) in light of the participation in the transaction of the appellant’s then parent company as guarantor. Under the licence fee order, the parent company is named the party and its taking up of the liability as guarantor is in clause 19.1 at page 418 of the book. That is important because under the licence fee order the obligation to make the payments could only ever fall on the holder of the transmission licence. But the liability to make the payments that arises under the agreement has another dimension than that given by the licence fee order. Not only does the appellant bind itself separately to make the payment, its parent contingently also binds itself to make the payments.

There is another aspect of our second approach which, in our submission, is one of the strongest and simplest indicators that these payments had a capital character and that is that they were fixed in amount and limited in number. That was a matter which was, in our submission, correctly emphasised by both Justices Edmonds and McKerracher below. They emphasised it in distinguishing this case from Cliffs International, having particular regard to the reasoning of Justice Jacobs in that case.

If I could ask the Court to go to Cliffs International? It is Cliffs International Inc v Federal Commissioner of Taxation [1979] HCA 8; (1979) 142 CLR 140 and the passage of Justice Jacobs’ judgment that I want to take the Court to is at page 173. What his Honour did was to set out four criteria and what he said about those criteria was this, beginning at about point 7 of the paragraph at about point 7 of the page:

I have not been able to discover a case where payments have been held to be outgoings of a capital nature when all the following features are present: (a) the asset right or advantage was of a depreciating character and of limited life; (b) the obligation to make the payments in question continues throughout the life of the asset right or advantage or the entitlement of the taxpayer to the asset right or advantage; (c) the amount of the payments is recurrent; and (d) the amount of the payments is not fixed but is dependent on the use made of or profits derived from the asset right or advantage.

As Justice Edmonds pointed out below, the appellant emphasises that the payments were imposed on the holder of the transmission licence but that is not enough. The obligation to make the payments did not continue throughout the life of that asset, so his Honour Justice Jacobs’ criterion at (b) is not satisfied and neither were they dependent on the use made of the licence or whether or to what extent profits were, in fact, derived from its use, so the criterion (d) is not satisfied.

The other aspect which distinguishes this case from Cliffs International was that in Cliffs International the payments were truly contingent. The undertaking of mining activities by the purchaser in that case is what enlivened the liability to make the payments there. Here the payments were to be made on specified dates in any event. There was nothing undertaken in the course of the appellant’s business which would enliven the liability.

In the fact that the payments were fixed in amount and limited in number, they are to be contrasted with section 163(3)(a) which is the source of the requirement in the licence which was issued, that the licensee “pay specified fees and charges”. I am referring to 163(3)(a) of the Electricity Industry Act, of course, but they are important words in section 163(3)(a) and they are the words “as a condition of the licence”. So the Regulator-General can require the licensee to pay specified fees and charges as a condition of the licence. We would say that is in respect of its use.

Section 163(4) also has something to say about how those fees and charges were to be set, that is, having regard to the administrative costs of the Regulator-General in administering the regulation of the electricity industry. So those fees were to be in some measure commensurate with the appellant’s use of the licence as a participant in the industry distinct from these imposts fixed in amount and limited in number.

Finally, if I could just briefly say something about our paragraph 14(i) which is one of the last indicators we say looking more broadly into the circumstances that the payment is a capital. The appellant says we must look from its point of view in determining what the payments were for. Well, it is not in dispute that the appellant itself treated the payments as a cost of acquisition in its audited accounts.

NETTLE J: How is that relevant?

MS SYMON: Well, it is relevant in the sense that if one asks what the payments are for from the appellant’s point of view and one looks at all the other circumstances and says these look like a cost of acquisition, then it is another factor which points to the payment as a cost of acquisition because the appellant itself treated them as such.

NETTLE J: Well, at most it could be relevant as an admission of fact, what would the fact be that was admitted?

MS SYMON: Well, no, your Honour, we would not put it that way that they are an admission of fact. We would simply say that they are an indicator of the character of the payments.

NETTLE J: It is a legal question. What they think is the answer is irrelevant, surely.

MS SYMON: It may be, your Honour, but we do not say it is decisive of itself, because these arguments about accounting treatment never are. We simply say it is a matter which points to the character of capital. Not decisive of itself, but important as part of the consideration of the whole of the facts and circumstances.

NETTLE J: I see. Thank you.

FRENCH CJ: Incidentally, although the recital F refers to the total amount payable to the State, the total purchase price was payable to PNV, I think, under clause 2?

MS SYMON: Under clause 2 it was. The recital is interesting, I suppose, your Honour, in the sense that the State and PNV were very much equated. One way or another, the payments to the seller were acknowledged in the agreement as being payments which would find their way to the State.

GAGELER J: Could I just ask a question about paragraph 14(i) – does that proposition involve some implicit relationship between the practical business standard that is applied for the purposes of determining whether or not an outgoing is of a capital nature and applicable Australian accounting standards and provisions of the corporations law – is that the connection you are seeking to draw, or not?

MS SYMON: We do not put it that highly, your Honour. We simply say the payments were treated as a cost of acquisition and that is interesting in the context of an inquiry when one must look from the point of view of the very person who treats it that way. But the technical accounting questions in our submission are not material. That is why it is really a small factor, but again, it is an indicator.

If I could then come to the appellant’s reply at paragraph 5, our case is not as it is put by the appellant in its reply, that is, we do not say that any payment which has a causal connection to or contributes to the acquisition of a capital asset is of a capital nature. Cliffs International tells us otherwise, and we do not say that Cliffs International was wrongly decided. It was a matter which turned on its own facts. It was correctly decided on its facts. This case turns on its own facts. In our submission, the conclusion ought to be a different one.

Neither do we contend that Morgan was wrongly decided, just that the appellant reliance on it is misplaced. It is misplaced for the reasons that we give at paragraph 27 of our submissions, the substance of which is that rates are ordinarily allowable deductions. In the language of the Court in that case at 520 to 521, the rate forms an outgoing which is recurrent and is inherently on account of revenue.

There was no question as to the character of the rates which were the subject of the inquiry there, whilst character is the question here. It is our submission that the question here is not answered by looking to cases where character was not in issue. If a payment is inherently on revenue account, it can be seen that it is not paid for the asset, but whether these payments are paid for the asset or for the advantages of the business which operates in the regulatory framework is the question here.

The contrast is to be seen when one looks at the Tata Hydro-Electric Agencies Case. It is Tata Hydro-Electric Agencies Ltd, Bombay v Commissioner of Income Tax, Bombay Presidency and Aden [1937] AC 685. That was a case which also concerned the assumption by the purchaser of a business of liabilities of the seller to a third party, and the character of payments subsequently made in discharge of the obligation so assumed.

We have set out the relevant passage at paragraph 15 of our submissions and what it reflects is many of the features which we say point to these payments having the character of capital, which is set out in paragraph 14 of our submissions. The passage is at page 695 of the report, which I would ask the Court to go to. Beginning at about point 3 of the page is their Lordships’ conclusion that:

the payments in question were not expenditure so incurred by the appellants. They were certainly not made in the process of earning their profits; they were not payments to creditors for goods supplied or services rendered to the appellants in their business; they did not arise out of any transactions in the conduct of their business. That they had to make those payments no doubt affected the ultimate yield in money to them from their business, but that is not the statutory criterion. They must have taken this liability into account when they agreed to take over the business. In short, the obligation to make these payments was undertaken by the appellants in consideration of their acquisition of the right and opportunity to earn profits, that is, of the right to conduct the business, and not for the purpose of producing profits in the conduct of the business. If the purchaser of a business undertakes to the vendor as one of the terms of the purchase that he will pay a sum annually to a third party, irrespective of whether the business yields any profits or not, it would be difficult to say that the annual payments were made solely for the purpose of earning the profits of the business.

In our submission, that passage could be applied almost word for word to the payments here. But their Honours go on to make a further observation, which is important in the light of Morgan. They draw a distinction between the outgoings they were concerned with there, and the assumption of the liability they were concerned with there. I think, with respect, your Honour Justice Nettle’s example, about five lines up from the bottom of page 695 of the report:

The case of a transferee of a business undertaking liability, for example, for the rents under current leases of the premises in which the business was carried on by the transferor and is to be carried on by the transferee is quite a different case, for the rents paid are clearly an outlay necessary for the earning of profit –

just as the rates which were the subject of consideration in Morgan were, in the language of the Court in that case, inherently on revenue account.

NETTLE J: And if so, why not the licence fees that must be paid in order to keep the licence?

MS SYMON: In our submission, it is that these payments fall on the other side of the line, and it is the line that is drawn in the Tata case, because they were payments assumed – the obligation to make the payments was assumed – in order to obtain the transfer of the assets and critically, in Tata Hydro-Electric, and indeed for Justice Jacobs in Cliffs International, the payments were to be made irrespective of the profits which the company might make.

The assumption of the liability and the nature of the liability undertaken put them on capital account and distinguished them from payments which were made in the process of deriving income. I have closed Tata Hydro-Electric, they use the language differently, but the distinction is important because what one sees in Tata Hydro-Electric in particular is a coming back to the language of the section, or the language of the test.

What one is concerned with is not just the question, are these payments payments of capital? One is also equally concerned with the question, are these payments on revenue account, that is, are they payments which are made in the process of operating the business or deriving the income? One has to be able to say yes to that question as well as being able to say no to the question as to whether they are payments of capital, that is, are they payments which are made in respect of the profit-yielding structure?

NETTLE J: It is just that their Lordships appear to recognise in the last six lines of 695 that even though the purchase of a business might covenant as part of the consideration of its acquisition to pay the rental under the assigned lease, nonetheless, the rent would remain an outgoing on revenue account because it would be necessarily incurred in carrying on business for the production of profits. If that be so – and plainly enough it is – then why is it not also true of a covenant to pay licence fees under a licence to be acquired, failure to pay which would result in the loss of the licence?

MS SYMON: In our submission, it is because this is not a covenant to pay licence fees under the terms of the licence. As our learned friends concede, the payments are a separate matter, but they are a separate matter to the licence. We say what they are not a separate matter to is the acquisition of the business and there - - -

NETTLE J: So much is accepted. It is plainly – you have nailed it, if I may say so, that it is part of the acquisition of the business.

MS SYMON: Yes.

NETTLE J: The point in the last six lines of page 695 to which you took us is that when a purchaser of a business covenants as part of the consideration for its acquisition that he will pay rents due under the lease which is acquired as part of the acquisition, the lease outgoings – the rent – remains an outgoing on revenue account.

MS SYMON: Yes.

NETTLE J: If so, why not also if the purchaser of a business covenants to pay licence fees under the licence to be acquired.

MS SYMON: That would be true if one was talking about the licence fees that were payable under section 163, that is the ongoing fees and charges which were payable in respect of the use of the licence. These payments are not made in respect of the use of the licence. They are special payments fixed in amount and limited in number and, indeed, they are paid for the acquisition of the assets and for the benefit to the regulatory framework and the regulatory framework is part of the profit yielding structure of the business.

There is a difficulty in relying too closely on what is said in Tata Hydro-Electric there, for the same reason there is a difficulty in relying on what is said in Morgan, because the character of an outgoing of rent and the character of an outgoing of rates is not in issue and so in a way the question is asked and answered. But here, one has to ask the question and look to the facts and circumstances to answer, just as happened in Tata Hydro-Electric. Looking into the facts and circumstances and the contractual arrangements made there, there was a different answer and, in our submission, this case falls on that side of the line.

So one might say, looking at Morgan and looking at the distinction made in Tata Hydro-Electric and, indeed, looking at Cliffs International, that there is what you might call a carve-out, that is, payments which are inherently on revenue account that are paid in connection with an acquisition will be revenue outgoings when they come to be made.

So in Cliffs International once one could see that the payments were, in effect, payments of royalties, the answer was a simple one because royalties are inherently payments on revenue account. These payments, in our submission, are not payments inherently on revenue account because of the background to their making and because of their taking up as an integral part of the mechanism by which the assets were transferred.

GAGELER J: Ms Symon, the statutory question addressed in Tata was whether the expenditure was incurred, and I am quoting solely for the purpose of earning profits or gains. Now, are you relating that statutory language to the statutory language of section 8-1 and, if so, which bit?

MS SYMON: We are not, your Honour. In our submission, the substance of the reasoning in Tata Hydro-Electric stands, notwithstanding any difference in the language of the statutory test to be applied, and the difference in the language was noted in both Colonial Mutual and Cliffs International. Indeed, Acting Chief Justice Williams in the Colonial Mutual Case specifically noted the difference in the language and dismissed those differences as relevant.

So, when one looks at Colonial Mutual, one sees Acting Chief Justice Williams relying on Tata Hydro-Electric. In Cliffs International, Tata Hydro-Electric is relied on by Justice Gibbs, and also Justice Jacobs. We have noted the relevant passages at paragraph 16 of our submissions. If the Court would just note that we should have included there reference to Justice Jacobs’ consideration of the case at 174, point 3 and 174, point 5 of the report in Cliffs International. Have I dealt with that question, your Honour?

GAGELER J: As well as you can. Thank you.

MS SYMON: The fundamental point which emerges from consideration of these cases is that each case turns on its own facts and circumstances, and it is our submission that the facts and circumstances of this case reveal that the payments, when made, were made for the transmission assets. They formed part of the price for the assets and that there is nothing in the wider circumstances which indicates that the payments were not made for the assets, or indeed, for the benefits of the regulatory framework. Insofar as we say that it can be said the payments were made for the assets - - -

FRENCH CJ: When you say for the benefits of the regulatory framework, do you mean anything more than for the licence with all the statutory things that attach to it?

MS SYMON: No, your Honour. The regulatory – well, the licence is part of the regulatory framework. The regulatory framework - - -

FRENCH CJ: I was wondering what you really mean by that.

MS SYMON: What we are particularly concerned with is the tariff order. The tariff order regulated the revenues and the imposts were a mechanism for adjusting those revenues. So because they were so closely related to the tariff order which was an important part of the regulatory framework, if not the key part, then these payments are part of the regulatory framework. The benefits of that regulatory framework were primarily the predictability of the revenues which the transmission company would earn, as well as the ability to outperform the assumptions which underpinned those revenues.

That is why we say that there are two strands. One is under the asset sale agreement the payments are made for the assets because of the machinery that is established by that agreement and even if one leaves aside the asset sale agreement one can see that the payments are made for the benefits of that regulatory framework which, in our submission, is part of the profit-yielding structure of the business. They were payments put in place for the purposes of the privatisation as part of the regulatory framework and therefore formed part of the establishment of the structure under which the business would operate into the future.

In that respect, it is our submission that this case and the payments here are analogous with those considered in United Energy, and that when one understands the parallels between that case and this, there ought not to be a different result in this case. In that case, all members of the court found that the payment of imposts there, which were referred to as “franchise fees”, which were imposed on the electricity distribution companies under section 163A were on capital account, and the franchise fees there did the same things as the imposts here. They enabled excess revenue to be paid to the government, that is, they were a way of extracting excess profits. That is explained by the majority at 184D to F of the report.

Like the payments here, the franchise fees in United Energy also came about as a result of a review in anticipation of privatising the distribution companies. That appears from Justice Lockhart’s judgment at page 173D of the report. Indeed, as the Court also sees from page 189E of the report, the franchise fees there were imposed by two Orders in Council. The first was made in June 1995 for the 1995 year. Then the taxpayer was sold, and a second order was made in August 1995 which dealt with the remaining years.

Again, the initial Order in Council covering the initial period was made ahead of the privatisation, the sale of the taxpayer – and the advantage to be gained by the payment of the franchise fees was expressed in the explanatory memorandum, which is set out in the reasons at 187A – the relevant part is set out at 187A – and they were described as:

designed to capture for the government the ‘monopoly rent’ that would otherwise be available –

Like the distribution companies, the government review revealed that the transmission company would earn excessive revenue, or monopoly rents, and like the distribution companies, the payments imposed on the transmission company are to be appropriately viewed as a fee payable for the benefits it would enjoy as a monopoly provider, albeit a regulated monopoly provider.

The other important parallel between the two cases is that for both the distribution companies and the appellant, the required payments were the means of adjusting excess profits the operators would otherwise enjoy during the remaining term of the tariff order. In that, in each case, the required payments were an integral part of the industry’s regulatory framework, the key aspect of that regulatory framework being the tariff order and the regulation of the revenues.

NETTLE J: How does that legitimacy of that reasoning stand in light of the subsequent decision of this Court in CityLink?

MS SYMON: In our submission, CityLink is a different case. CityLink turned on quite different facts and the critical aspect of the reasoning in CityLink was that the outgoings which were in question there were not made for the acquisition of an asset. They were ongoing payments made for the use of the asset and that turned on the construction of the concession agreement in question.

NETTLE J: Thank you.

MS SYMON: At paragraphs 29 to 38 of our submissions we made some points about when the appellant’s liability to make the payments were incurred. I do not propose to go to them in detail. They arise from a principle – a so-called principle which our learned friends set out in their submissions at paragraph 34. Ultimately, we say the whole discussion of incurrence is misconceived. If we are wrong in that, our learned friends are wrong in when they say the payments were incurred in any event. But what the appellant proposes at paragraph 34 is that the issue of characterisation must be determined at the time the expenditure is incurred. There is no authority cited for that proposition and, in our submission, the principle simply does not exist.

The authorities that are cited go to the question of when an outgoing is incurred. They have nothing to say about the character of an outgoing which is the question here. What they are concerned with is the timing of the deduction, that is, when may a deduction be claimed, not with whether an outgoing is deductible at all.

The question of characterisation focuses on something quite different. It focuses on the outgoing itself and what is to be said about it, having regard to the facts and circumstances of its making. That question arises when a deduction is claimed. So, for example, in Colonial Mutual, the question of the character of the outgoings arose when a payment was made and a deduction claimed for it, not at the time of the contract for the sale of land.

The Court found the character of the payments when made to be determined by the undertaking of the taxpayer to make them in the pre-existing contract of sale. That was some eight years before the first payment was made because the undertaking was to pay a percentage of rents in a property to be built. So the first payment was made after the property was built and tenants installed.

You could also look at the proposition through the prism of the circumstances of United Energy where one was concerned with similar imposts as those imposed here. The deductibility there was the subject of a private ruling made around the time the first payment was due and the Court, as we know, decided the imposts paid were capital in character. They gave consideration to the Order in Council requiring the payment of the imposts – the terms of section 163A under which it was made and the facts and circumstances under which the imposts came to be required.

They did not turn their minds to the question of whether or not the payments there considered would be incurred at the time they were made or whether they were incurred as a result of the Order in Council. That is beside the point. That the outgoing might be incurred at the time the payment is made, which is not the case here in any event we say, does not mean that consideration of the whole history and background to its making are not part of the factual matrix by which its character is to be determined.

The appellant puts up another straw man, which we deal with at paragraphs 39 to 42 of our submissions, and it is this notion that if you call the imposts, or these payments, a tax, then somehow that makes them on revenue account. But as I have already indicated, stamp duty is a tax for which one gets nothing - - -

FRENCH CJ: I think we have been there.

MS SYMON: Yes. But, ultimately, the point we make about what I am calling these “straw men” is that they really beg the substantive inquiry into the determination of the payments. The appellant’s submissions constantly focus on identifying a correct test or identifying some principle, but they do not really descend to engaging with the identified question of what were the payments for.

So the appellant’s positive case – that the payments had a revenue character – lacks substance. It appears to be founded on little more than that the payments were imposed on the licence holder, and they were payable at a time when the licence holder was in possession of the assets and in fact conducting the transmission business. That is as it is put at paragraph 54 of their submissions. But it does not follow from those factors that the payments were on revenue account, just as it does not follow that the payments were on revenue account if one says one gets nothing from the payments or the promise to make the payments.

The fact that the appellant might get nothing does not mean that the payments were on revenue account in the sense of the fundamental language of the test which is, were they part of the process by which the business operated to earn its profits? That question is not answered by saying we did not get anything for them, we were the holder of the transmission licence and that is why we had to pay them and we were running the business when the payments had to be made.

At the end of the day, the focus is unduly narrow when one only looks at those matters and that is, in our respectful submission, the error that her Honour Justice Davies made below in dissent. It does not take into account the whole of the facts and circumstances and, in particular, what the asset sale agreement sets up either legally or what it says about the facts and circumstances in determining the question of character.

Our learned friends particularly rely on the proposition that the thing that produced the assessable income was the thing that exposed the appellant to the liability discharged by the expenditure. In our submission, that is superficial reasoning and it is wrong. It draws on the language that one finds in the Herald & Weekly Times Case, Herald & Weekly Times Ltd v FCT [1932] HCA 56; (1932) 48 CLR 113 and the particular language is at 118.

So, relying on this proposition that the thing that produced the assessable income was the thing that exposed the appellant to the liability discharged by the expenditure, our learned friends say and her Honour Justice Davies said because of that the payments are to be seen as an expense in the business operation of the appellant and the obligation to pay the impost flowed as a necessary consequence of holding the licence.

The error is apparent when one recalls what the principle expressed in Herald & Weekly Times was concerned with. It was concerned with the 8-1(1) question, in particular whether there is sufficient nexus between an outgoing and the production of income to say that the outgoing was incurred in gaining or producing the income. That principle is not applicable to determining the character of the outgoing for the purposes of section 8-1(2) which is the question here. Many capital outgoings could be said to have a nexus with the production of income, but that is not the determinant of their character. If the Court pleases.

FRENCH CJ: Thank you, Ms Symon. Yes, Mr Steward.

MR STEWARD: Some short matters arise by way of reply if I may address them in the order of my learned friend’s oral submissions today. Looking at the positive limb, the proposition that a payment of tax on profits is not deductible, and allied with that the proposition that a payment which has been sourced from a fund which is akin to profits is not deductible are propositions which derive from Justice Lockhart’s judgment in United Energy. Those propositions are foreign propositions.

They are not supported by the statutory language of section 8-1 which does not mention profits at all. This Court has on at least two occasions held that payments out of profits are a deduction under section 51(1) of the 1936 Act. The first did it in the Midland Railway Case that I took this Court to earlier this morning which articulated the correct test. It rejected the profits test and said that the question is – the only question is, is it a payment out of the precise fund called the taxable income of the taxpayer? If it is that then you are not going to get a deduction because you cannot possibly show that it was incurred in gaining or producing assessable income. But other than that, payments which are grounded in calculations about profits may very well be incurred in gaining or producing assessable income.

Midland Railway is an example. Another example that springs to my mind is the decision of this Court in Emu Bay Railway (1944) 71 CLR 597. In that case, the payments were dependent upon the availability of profits and, by majority, three Judges of this Court said that because there were no profits in that year nothing had yet been incurred as a liability. But two Judges said it was deductible, and what Chief Justice Latham said was that if it had been incurred it plainly would have been deductible, even though it was payable out of their profits. That is because that simply is not an important point under our Act.

My learned friend’s reliance upon English decisions such as Dowdall needs to be considered in the context that Dowdall was a case under the English Income Tax Act which imposes tax on profits. I will give you the reference to the statutory test – I think it is at page 410 of the speeches of their Lordships, in the speech of Lord Reid in the second paragraph:

Tax under this Schedule shall be charged in respect of—(a) The annual profits or gains arising –

This Court has on a number of occasions warned about the use of English income tax cases in our system which, like the US Internal Revenue Code, does not tax profits but taxes taxable income, being a fund comprised of assessable income less allowable deductions.

We can see an example of such a warning in the Nilsen Development Case [1981] HCA 6; 144 CLR 616 at 628. At 628, about the middle of the page in the judgment of Justice Gibbs, as his Honour then was:

This decision may be explained by the fact that under the English legislation it is necessary to compute the profits or gains of the taxpayer in the year in question . . . In deciding how the profits are to be ascertained the courts have regard to ordinary commercial principles. Under the Australian legislation, however, the question what losses and outgoings arising in the course of a business are to be deducted is a matter covered by s. 51(1) and depends, inter alia, on the question whether the loss or outgoing has been “incurred”.

Ultimately, of course, as this Court recognised in its earlier decision in Boulder Perseverance, the very relevance of whether a payment is out of profits or not turns upon the particular statutory regime. There is no a priori principle out there a payment of tax on profits is never deductible. It just depends upon the language of the statute.

Now, could I take you back momentarily on this topic to appeal book 1, page 99, because my learned friend placed reliance upon this and persistently stated that the imposts were designed to ensure that the taxpayer had the right level of profits. Bearing in mind that we are looking at this from the perspective of the taxpayer, knowing that the government has undertaken a calculation designed to reflect those three things tells one very little, if anything at all, about the quality of the payment when made by the taxpayer. All the taxpayer knows is that he must pay fixed sums over a particular period and if the taxpayer were to ask, why do I have to pay this, he is told in the information memorandum it is because your gross revenues are too high and they must be reduced. That is about as high as it gets.

But even then, if one looks at (a), (b) and (c) in the middle of paragraph 99, and asks the question by reference to the statutory language of 8-1, if one has to make a payment that is calculated to reflect those integers, why is it denied deductibility? Each of those integers reflects calculations that may or may not reflect profits under various iterations of various accounting standards. Take, for example, the straight line depreciation. This information memorandum tells you at page 229 of the appeal book that the depreciation there adverted to, second paragraph, is significantly different to the depreciation available under the Income Tax Act.

We then go back to United Energy and ask the question, what is one to do with Justice Lockhart’s judgment? His Honour did not refer to Midland Railway. He did not advert to the correct test. We do not know why, but he did not. My learned friend said nothing about this at all on her feet today. We submitted that the result is right, but we do submit that the course of reasoning of his Honour Justice Lockhart is problematic, because it appears that the key decision of this Court was not deployed and addressed. Moreover, it did not take account of the fact that in Midland Railway a deduction was allowed by this Court for a payment out of profits.

We also maintain that the regulatory regime addressed in United Energy is significantly different. We can see that very obviously – if I could take the Court to page 187 of the judgment briefly.

FRENCH CJ: I notice that Mr Shaw and Mr Pagone are both appearing.

MR STEWARD: I noticed that too, your Honour. You will see just under point F on page 187 the very specific statutory monopoly given to distributors for a period of five years. They had a legal monopoly over customers called “non-contestable customers” for five years. After five years, under the Victorian regime, there would be full competition. We do not have anything like that here.

Then at page 194, Justices Sundberg and Merkel address the submission made by Mr Shaw, which is very similar to the submission we make here, in the last paragraph:

Counsel for the taxpayer contended that the franchise fee is a compulsory exaction to redress the excess profits obtained from the statutory monopoly, and that therefore no enduring benefit enured to the taxpayer.

It has a ring of familiarity about it. But that was rejected because of the particular regime in place, and we see that in the next paragraph, where their Honours say:

In our view the submission takes too narrow a view of the franchise fee. Immunity from competition in respect of franchise customers in the licence area is secured by the exclusivity conferred under ss 162(2B) and 163A. The franchise fee is payable under s 163A for that exclusivity.

We do not have that here and it was not put below that we did. No judge below decided that the payment here was a payment for legal exclusivity in the way that their Honours concluded in United Energy. Then there was the proposition put that the manner of calculation was critical for the proposition that we failed the first limb. That is not correct. Again, we need to return to Midland Railway where something similar was said. This is Midland Railway in the Full Court, if I could briefly take the Court to, I think it is page 317 in the judgment of Justice Dixon as his Honour then was, in the top of the page at about point 3, his Honour says, at the end:

“it is the quality of the payment that matters and not its admeasurement”.

That proposition was deployed by the taxpayer in CityLink successfully. It is referred to in footnote 79 at paragraph 135 in the judgment of Justice Crennan, where a similar argument was deployed by Mr Shaw again to say that the payment in CityLink was truly not incurred because of the waterfall structure which ensured that the payments would not in fact be made until 2013, and the Court decided that that fact did not prevent its incurrence in each of the 1997, 1998 and 1999 years because the way it was measured did not matter. Yes, it was measured in a way which made it deeply subordinated to other creditors, but so what.

Can I then very briefly address the assumption proposition? We say, and we repeat, that as a matter of practicality, we could not and did not assume any liability to pay the imposts because the asset sale agreement ensured that PNV would never be the holder of the licence when the time came to pay it; nothing to assume from PNV.

Let us assume that I am wrong about that. Let us assume that there was a liability assumed. With respect, that tells you nothing about the quality of the payment when the time comes to pay it. Let me give you an example. You can sell a business and the purchaser can assume liability for the employee entitlements that had accrued up to that point and, indeed, the purchaser in calculating how much to pay for the business will take into account that liability, but when the time comes to pay out that holiday leave, that sick leave or whatever it might be, that payment will be deductible.

Some liabilities assumed will be on capital account. Some liabilities assumed will be on revenue account. Be that as it may, it will depend upon their quality and nature when they are incurred. So, here, saying that the liability has been assumed, it takes us nowhere.

Then my learned friend said that the imposts were really for securing such things as the natural monopoly and the other advantages of being the owner of the business. We disagree. What secured that was paying $2.5 billion. The $2.5 billion bought the assets and bought the licence which provided those advantages and benefits such as a natural monopoly. The regulatory regime, the tariff order, that my learned friend said was secured by these payments did not confer upon the appellant taxpayer any particular advantages at all. The tariff regime restricted its revenue, not enlarged it. Indeed, we can see that the very proposition it put was rejected by the learned primary judge. If I could take the Court briefly to it? I think it is paragraph 86 at appeal book 3, page 1002. No - if the Court just bears with me for one moment. I do not think it is page 1002.

FRENCH CJ: I think it is paragraph 86.

MR STEWARD: I beg your pardon, your Honour.

FRENCH CJ: Paragraph 86 appears to be apposite to the point.

MR STEWARD: Yes, I am indebted to the Court. You will see that her Honour specifically rejected the proposition that my learned friend put. Then my learned friend made the submission that some taxes may be on revenue account and some on capital account. It is very difficult to predict with certainty whether that will be so or not, but the one feature of a tax which we emphasise and which we do say is relevant to the negative limb is that a true tax is not a fee for services.

If one recalls the famous definition of tax from the Chicory Marketing Board Case, the compulsory exaction for public purposes that is not a fee for service. In United Energy, inferentially, because of the finding of Justices Merkel and Sundberg, what they paid was not a tax. It was the consideration for the grant of statutory exclusivity. Our point is, is that if it is truly a tax, by its very nature, you are not supposed to be getting something back, no exchange, no payment for services and that will impact and infect and be relevant to the proper characterisation of the burden of the tax being on capital account or revenue account.

As it happens many taxes are deductible. Petroleum resource rent tax is deductible. Sales tax was deductible and stamp duty incurred - I call it duty actually now, incurred on an acquisition of land, may be deductible. The fact that it is connection with a capital transaction is neither here nor there. This Court in Steele’s Case [1999] HCA 7; 197 CLR 459 debunked that theory. You will recall that in Steele’s Case, Mrs Steele had borrowed money to build a hotel. She incurred interest and the Federal Court denied the deductibility of the interest because they said it was a cost of funding the capital project. It was bound up with and integral with this capital project, the hotel.

This Court rejected that proposition and said the fact of the association with capital, the fact of association with profit-yielding structure, is not sufficient to reach the conclusion necessarily that the relevant impost is for that capital advantage. In Steele’s Case, the interest was for the regular use of the money, the recurrent use of the money over the period of the loan and thus it was held to be deductible.

Similarly, in CityLink – if I may advert to that case once more – there was no doubt that the concession fees that were incurred in each of the years in dispute were bound up with the profit-making structure of the tollway, no doubt at all. But that is not enough. The proposition put by my learned friend is, with the most profound respect, too broadly stated.

Could I say something very briefly about the significance of the adjustment that my learned friend relied upon? We in fact rely upon the adjustment that was made to the impost precisely because it demonstrates the close connection between the payment of the impost and the derivation of income from being the owner of the transmission licence.

As Justice Nettle observed, originally it was intended that you would be the owner of the licence earlier than what in fact happened. The reason for the adjustment was because in that first quarter of that year we were not going to be the owner of the transmission licence and thus not deriving MAR, so the adjustment was made to ensure that the thing did not kick in until we became the owner of the licence and came to enjoy MAR.

In that respect, my learned friend relied upon certain aspects of the evidence below concerning the negotiation of the asset sale agreement. There were some aspects of those negotiations that she did not take the Court to. If I could ask the Court to go appeal book 1, briefly, page 61. This is the affidavit of Mr Keller who was the CEO at the time. Paragraph 21 of Mr Keller’s affidavit, the final paragraph, Mr Keller notes:

GPU submitted its bid . . . on 10 October 1997. The bid offered a purchase price . . . $2,469,000,000 . . . The section 163AA fees were payable over and above this purchase price.

The reason why I advert to that is that Mr Keller’s evidence was unchallenged. There was no cross-examination of him whatsoever. These statements were not submitted to be incorrect. Earlier in his affidavit, paragraph 20, he correctly deposes that of course the imposts were taken into account in determining the bid price. All future liabilities, whether revenue or on capital account, are looked at in order to do a cash flow model that is then discounted and then tells you what an appropriate bid price should be.

Then if I could take the Court very briefly to the affidavit of Mr Cohen who acted for the government – appeal book 2, page 78 - I beg your pardon, it cannot be 78, appeal book 2, paragraph 30, which appears at 783, there Mr Cohen deposes that he was a member of the Victorian Government’s negotiating team:

There were a number of competing bidders . . . and I attended a number of meetings with bid teams and their advisors.

Critically, he says -

The requirement to pay the section 163AA licence fee had already been announced by the Government and was not a matter for negotiation with bidders and indeed it was not negotiated or discussed at any of the meetings I attended.

Again, Mr Cohen was not cross-examined. He was not challenged on that. That evidence strongly supports the proposition that we put this morning, namely that the impost was a fact of the regulatory environment that would arise regardless of who was the successful bidder. It certainly was not – and let there be no doubt about this – the impost was certainly not disguised consideration. That was not suggested below, it was not put to any witnesses that it was, the opportunity to put it was there, not taken.

Two more matters: the reliance upon the quality of the payments being fixed in number and limited. The explanation for that arises from the regulatory regime. Your Honours will recall that two aspects of that regime, (a) the State Government was not able to reduce the MAR because it had already had its tariff order out there and the distributors were already running their businesses; (b) the opportunity to reduce the MAR would first arise at the end of 2000. That tells you why the imposts run over those years. It is derived from the regulatory explanation.

All we would say in closing is at the end of the day one must ask the question on the evidence what were the imposts for and they were for the purpose of reducing gross revenue. That is plain. They were not, with great respect to our learned friends, for the assets purchased. We paid a separate sum for that. If the Court pleases, those are the submissions in reply.

FRENCH CJ: Thank you, Mr Steward. The Court will reserve its decision. The Court adjourns until 10.00 o’clock tomorrow morning.

AT 4.09 PM THE MATTER WAS ADJOURNED